On April 30, 2012, Edward Conard, a former partner for the financial management company Bain Capital and a multimillionaire who retired at age 51, sat across from Jon Stewart, host of "The Daily Show," to promote his new book. Conard smiled and stared intently through his black-rimmed glasses as Jon Stewart, the liberal host of the comedy show, held up his book and described its contents. Conard’s book argued that America’s economy would be stronger if people like Conard were even richer and the country had even higher levels of economic inequality.
Stewart was puzzled by Conard’s argument and joked that it didn’t seem right because inequality in the United States was approaching the level in countries with “kidnapping-based economies,” generating laughter in the audience. Then Stewart shifted to an opening that would give Conard a chance to explain himself. “My question to you about the premise of the book,” Stewart stated, pausing for effect before setting up his punch line, “is huh?”
Conard laughed along with the audience, and then launched into his argument that great rewards for the “most talented” people were the secret to America’s success. Making the rich richer is good for everyone, he claimed, because high levels of inequality provide strong incentives for risk taking and innovation that are essential for economic growth.
Though Conard’s comments were provocative—indeed his book tour generated significant press, including a multipage feature in the New York Times Magazine—he was merely stating the barely hidden premise underlying supply-side economics. Supply-side economics, the misguided theory that has controlled economic policymaking for the past three decades, is built on the idea that inequality is good. Tax cuts for the rich and less regulation of business supposedly provide incentives for the wealthy to invest and work more. Enabling “job creators” to get richer helps us all, the theory goes.
Conard’s former boss at Bain, Mitt Romney, the 2012 Republican Party nominee for president, ran on a platform of supply-side policies, as have virtually all Republicans since Ronald Reagan was elected president. Even a number of prominent Democrats support supply-side policies and logic. Not only do these wrongheaded ideas about inequality have great political influence, but—until quite recently—they were largely shared by academic economists. For the past several decades, the idea that high levels of inequality were good for the economy dominated economic thought.
Fortunately, these flawed ideas are beginning to be challenged. Academics have begun to rethink their views about the decline of the middle class and progressive politicians are finally starting to openly contest the logic underlying supply side after years of failing to do so. It is about time because our economy is suffering deeply from a financial crash caused in large part by high levels of inequality. And though we may not have a kidnapping-based economy, as Stewart joked, the American middle class is so weakened that we are experiencing the kinds of problems that plague less-developed countries, including high levels of societal distrust that make it hard to do business, governmental favors for privileged elites that distort the economy, and fewer opportunities for children of the middle class and the poor to get ahead, wasting vast quantities of human potential.
The American economy has been thrown off balance because the middle class is so weakened and inequality so high. An economy that works only for the rich simply doesn’t work. To have strong and sustainable growth, the economy needs to work for everyone.
A strong middle class is not merely the result of a strong economy—as was previously thought—but rather a source of America’s economic growth. Rebuilding the middle class would provide the stable base of consumer demand necessary to increase business investment and job creation. It would also enable the country to fully develop the human capital of its people, increase the social trust that makes transactions possible, and balance political power to produce a government that works for the whole country, not just those at the top.
Elements of this line of thinking date back to some of history’s most prominent economists—from John Stuart Mill to John Maynard Keynes—but until the Great Recession of 2007–2009 snapped the field back to attention, most economists ignored the importance of the middle class. Now, as they revise their models and assumptions that failed to predict the financial crisis, economists are rediscovering classic scholars, opening their eyes to the work of researchers in other fields such as history, political science, and sociology, and developing promising new lines of inquiry to try to understand the role of the middle class.
The weakening middle class
The United States was founded as a middle-class country. On the eve of the American Revolution, America’s carpenters, shopkeepers, and farmers enjoyed a higher standard of living than workers in other parts of the world. Further, economic inequality was lower in the United States than any place else. In an era of kings and peasants, America’s middle class stood apart.
America had its share of rich people, and of course it had slavery. But even so, the rich were not that much richer than the middle class. As Peter Lindert, an economic historian at UC Davis, explains: “Compared to any other country from which we have data, America in that era was more equal.” Those who lived during America’s founding sensed that the country’s economic equality was special. Thomas Jefferson noted in a letter that “we have no paupers. . . . The great mass of our population ... possess property [and] cultivate their own lands.... The wealthy, on the other hand, and those at their ease, know nothing of what the Europeans call luxury.”
The strength of America’s middle class ebbed and flowed over time, especially as industrialization took hold. But after World War II, America returned to its roots and built a mass middle class that was the envy of the world, with rapidly rising incomes and decreasing inequality. The mid-1940s to the mid-1970s was a period “without extremes of wealth or poverty,” as Nobel Prize-winning economist Paul Krugman explains. To be clear, America in this era had rich people and poor people, but the bulk of society formed a prosperous middle class that was in relatively close proximity to both the top and the bottom.
Yet, over the past three to four decades, middle-class America has come undone. The American middle class was already hurting when the Great Recession struck and is now in deep trouble. While there’s no official definition of the middle class, it’s not hard to see that it is in decline. By most every measure, most Americans are struggling.
First, there is the basic level of income earned by the typical American. Median household income—meaning half make more and half make less—was lower in 2013 than it was in 1989. This means that middle-class households now earn less than they did two decades ago. Similarly, incomes for poor and even upper-middle-class households have also stagnated. It is true that over an even longer time period, the middle class have seen some income gains. But these gains have been quite small: over the past four decades, median compensation, including both wages and benefits, has grown at a snail’s pace of just 0.27 percent per year—far slower than the overall economy or output per worker. The miniscule gains that households have made have largely come because women have increasingly entered the workforce—meaning families are working longer hours, as they run faster and faster to stay in place. Indeed, the hourly wage earned by a typical man is less than it was in 1973.
Even these gloomy figures may be too rosy because they show what is happening to the typical household—but the typical worker is getting older, and older workers generally make more than younger workers. Income trends are even worse when workers are compared to those of a similar age from a few decades ago. Median incomes for male workers now in their thirties are about 12 percent lower than the income was for their fathers’ generation at the same age.
While incomes have been stagnant for most Americans, the cost of middle-class basics like healthcare and gas have risen much faster than inflation, and some basics like housing and college have risen at double the rate of inflation over the past four decades. It costs a lot more to maintain a middle-class lifestyle, but no matter their efforts most families have not been able to earn much more income. Not surprisingly, debt levels have jumped sharply—the average debt of middle-class families has nearly doubled since 1983.
In contrast to the middle class and the poor, incomes of the rich, especially the very rich, have grown by astronomical amounts over the past three decades: in 2007, the year the Great Recession started, the top 0.01 percent, the richest one in ten thousand, earned in today’s dollars the equivalent of about $38.8 million, compared to $6.4 million per year in 1979. Because of rapidly rising incomes for the rich and stagnating incomes for everyone else, the economic distance between the rich and the middle class has grown by leaps and bounds. CEO compensation, for example, increased from less than 30 times that of the average worker in 1978 to over 350 times what the average worker made in 2007. Though incomes for the rich fell during the Great Recession more than they did for the middle class, incomes for the rich have come roaring back, while middle-class incomes have not—so much so that income differences are now back to near the prerecession levels.
To picture how big these differences are, think of a strange building housing the middle class on the bottom floor and the very rich on the top story. In the late 1970s, the CEO’s penthouse would have been on the thirtieth floor, making this apartment building a tall one, but one that would fit in many American cities. In 2007, the penthouse was 351 floors up, meaning the apartment building would need to be more than three times the size of the Empire State Building.
The rich now make so much more than the middle class because they captured the vast majority of the economy’s gains over recent decades. The share of the nation’s income going to the top 1 percent has approximately doubled over the past three decades, while the share of income going to the middle 60 percent of income earners has fallen precipitously and is now stagnating near the lowest level ever recorded since the government began keeping track of the statistic. These changes in income share are “the equivalent of shifting $1.1 trillion of annual income to the top 1 percent of families,” according to Princeton economist Alan Krueger. Since the Great Recession ended, over 90 percent of the income gains have gone to the top 1 percent of income earners.
And wealth differentials are even bigger than income differences. The bottom 90 percent of Americans have lost wealth over the past two and a half decades and now hold only about one-quarter of the country’s wealth. In contrast, the top 1 percent have seen dramatic gains in wealth and now hold 40 percent of total US wealth. To put the wealth of the very rich in context, the average net worth of the 400 wealthiest Americans is “about the same as the gross domestic product of Brazil,” according to Forbes Magazine.
For most Americans, incomes are stagnant, debt levels are high, and they are taking home a smaller share of the pie than they once did and falling further behind the rich. This means, as economists put it, that the opportunities for the poor and middle class are increasingly constrained in comparison to those of the rich.
The emergence of middle out
As dramatic as these trends are, by themselves they were not enough to force economists to rethink their ideas about inequality. Rather, there were several developments that really pushed economists to pay serious attention to inequality and study its impact on the economy. Improved measurement of the incomes of the very rich helped, as did patterns of economic growth around the globe that didn’t conform to expectations, but most important was the Great Recession.
Traditional measures showed that inequality in the United States had become higher than in many other countries, including notoriously unequal ones like the Philippines, Nigeria, and Russia. But in recent years, economists such as Thomas Piketty and as UC Berkeley’s Emmanuel Saez developed more accurate data about the incomes of the very rich over time which showed not only that the top 1 percent in America took home a much greater share of the nation’s income than did the rich in most of the world, but also that the share the very rich received equaled record levels in American history. The improved data not only elucidated these comparisons but also enabled economists to perform more nuanced analysis than they had been able to do before.
At the same time as income data was improving, growth trends in many countries were defying economists’ models. Well before the Great Recession struck, it was becoming increasingly clear that the American economy grew more rapidly in the middle part of the twentieth century when the middle class was stronger than it did in recent, highly unequal decades. Further, other rich countries that were more equal were growing at least as fast as the United States—and some actually had higher per capita growth rates. Economists who studied growth, especially in the developing world, began to think that an important reason why countries like South Korea were growing much more rapidly than countries like the Philippines was because they had lower levels of inequality. NYU’s William Easterly, for example, argued that in countries around the world “middle-class societies have more income and growth.” In one of the more important papers in this line of research, Andrew Berg and Jonathan Ostry, economists at the International Monetary Fund, found that more equal countries tend to have significantly longer periods of growth while unequal countries had great trouble maintaining their growth for any sustained period.
These observations about growth around the world didn’t prove that inequality was harming the US economy, but they did at least suggest that the old ideas about inequality might be wrong and indicated the need for more research. This line of international comparative research became bogged down over data and methodological questions—and not every scholar came to similar conclusions—but the research clearly showed that simple assertions about inequality being good for the economy were not accurate and demonstrated that economists needed to think more deeply about exactly how inequality impacts economic growth. As Heather Boushey, the executive director of the Washington Center for Equitable Growth, and Adam Hersh, a senior economist at the Center for American Progress, wrote, this cross-country analysis indicated that economists “need to understand the mechanisms through which inequality and the strength of the middle class affect the economy.” The actual experiences of countries around the world showed that scholars had to start looking at how inequality and the strength of the middle class impacted the underpinnings of growth. Especially before the Great Recession, these international comparisons were critical for challenging economists’ preconceptions about inequality.
Then the Great Recession struck just as economic inequality in the United States was reaching the same level as had occurred right before the start of the Great Depression in 1929. The dramatic economic collapse forced many economists to look at inequality in a new way. Though the relationship between economic inequality and financial collapse is not as simple or direct as some have tried to claim, inequality and the weakness of the middle class clearly played a big part in driving the Great Recession. The Great Recession began in the United States and was so severe in large part because our financial regulations were weakened by the political power of Wall Street and because the middle class was heavily indebted. As Joseph Stiglitz, a Nobel Prize–winning economist, explained, “The most recent financial crisis has shown the errors” of ignoring inequality.
The debate of our times
After 30 years of political dominance, it is obvious that supply-side economics has failed in a number of ways and is thus vulnerable to a challenge from middle out. Supply side helped fuel the Great Recession of 2007–2009 by destabilizing consumer demand and encouraging the deregulation of Wall Street—costing the United States 8.7 million jobs and trillions of dollars in reduced economic growth.65 The Great Recession alone is more than enough reason to get rid of supply side. But even excluding the Great Recession and its aftermath, growth was much slower over the past several decades, when trickle-down was ascendant, than it was in prior decades. Even within the supply-side period, growth was weaker after President George W. Bush cut taxes for higher earners than it was after President Bill Clinton raised taxes on the rich.
Moreover, trickle-down’s supposed growth mechanisms haven’t occurred the way the theory predicted. Savings, investment, employment, and productivity didn’t increase after trickle-down policies were enacted, as a host of studies have shown. And budget deficits skyrocketed when tax cuts didn’t pay for themselves, contrary to the claims of trickle-down proponents.
President Barack Obama has taken important first steps to take advantage of the opening provided by the failures of supply-side economics, arguing in several important speeches that “our economy doesn’t grow from the top down; it grows from the middle out.” Importantly, President Obama has presented his argument as a direct challenge to the underpinnings of supply-side, stating that “we need to dispel the myth that the goals of growing the economy and reducing inequality are necessarily in conflict.” President Obama has even begun to explain some of the mechanisms of middle-out economics, noting, for example, the importance of middle-class consumer demand to the economy. And a number of progressive governors and other rising political leaders have started to make similar arguments.
These speeches have challenged supply-side economics in a way previous criticism has not. Previous criticism attacked supply-side indirectly—arguing, for example, that tax cuts make it harder to pay for important investments in education—but did not directly challenge the basic premise that the rich are job creators, or provide a comprehensive, alternative theory of economic growth.
But, even in the face of a direct challenge, supply side will not die easily because it is deeply ingrained in the thinking of both political parties. Supply side dominates the Republican Party and a number of leading independents and Democrats subscribe to its logic. Indeed, since the 1970s, taxes have been cut much more sharply for the rich than they have for the middle class, not just because of Republicans, but in large part because Democrats also supported these policies. Certainly many Democrats opposed these changes, but Democrats often provided the critical support necessary for the proposals to become law. President Bill Clinton, for example, signed into law a bill lowering capital gains taxes, which dramatically reduced taxes on the wealthy, especially the very wealthy, while doing little for the middle class—though he of course also increased income taxes in opposition to trickle-down orthodoxy.
Further, trickle-down logic can frequently be heard in the statements of prominent politicians who are not part of the Republican Party. To take just a few examples: Andrew Cuomo, Democratic governor of New York, said that tax cuts for business and individuals are “the centerpiece” of his agenda, and his announcement of a commission to study how to do so was seen as the kickoff to his reelection campaign in 2014. In 2013, Independent Michael Bloomberg argued that increasing the number of billionaires in New York City—even though it would increase inequality—would be a “godsend” because “they’re the ones that spend a lot of money in the stores and restaurants and create a big chunk of our economy.” Douglas Gansler, a Democratic candidate for governor in Maryland in 2014, announced that he planned to cut taxes on business to help generate growth, according to his campaign.
Trickle-down logic is also endlessly repeated in the media, where it is often accepted as fact. A recent study by Occidental College political scientist Peter Dreier and University of Northern Iowa communications professor Christopher Martin found that between 2009 and 2011 four elite media outlets (the AP, Wall Street Journal, New York Times, and Washington Post) frequently quoted people using the term “job killer” or used the term without attribution. In over 90 percent of cases, the media failed to provide evidence to back the claim and simply bought into supply-side dogma. Leading issues portrayed as job killers were proposals to increase taxes on business and the wealthy or to raise the minimum wage. That proposals to raise revenue for schools and roads or put more money in the pockets of workers were portrayed in such a negative light is exactly what we would expect after over 30 years of trickle-down economics.
As a result, it is fair to say that the trickle-down worldview has impacted policymaking for more than three decades. Not only is trickle-down still lodged firmly in place, but since the Great Recession, adherents of supply side have doubled down on their policies. The rhetoric supply-siders use may be shifting to be more supportive of the middle class, but their policies have gotten more extreme.
Republican presidential candidate Mitt Romney ran against Obama in 2012 by proposing tax cuts for the wealthy that were far larger than the cuts enacted by President George W. Bush. The budget proposal by the House Republicans in 2013 would have provided bigger tax cuts to the wealthy than even the Romney plan. Further, these federal proposals for additional tax cuts for the rich would likely have required tax increases on the middle class, according to a number of analyses. Similarly, Republican governors like North Carolina’s Pat McCrory, Kansas’s Sam Brownback, Wisconsin’s Scott Walker, and New Jersey’s Chris Christie have recently proposed policies that cut taxes for businesses and the wealthy, but raise them on the middle class. In contrast, supply-side proposals of the past cut taxes most dramatically for the wealthy, but still reduced taxes for most everyone.
That supply-side supporters have become even more dogmatic in the aftermath of the Great Recession is not particularly surprising. American history shows that proponents of the dominant theory often do not admit the error of their ways, but rather become even more strident as evidence mounts that their logic has failed.
Excerpted from "Hollowed Out: Why the Economy Doesn't Work Without a Strong Middle Class" by David Madland. Published by the University of California Press. Copyright © 2015 by the Regents of the University of California. Reprinted with permission of the author and publisher. All rights reserved.