What Happened to the “Social Contract”?

Yves Smith, commenting on an article by Martin Wolf, notes that 58% of every dollar of real income growth that was generated between 1976 and 2007 went to the top 1% of income earners and mourns the passing of “the deal”, the social contract that many here and in Europe have thought was eternal:

Now some readers may simply snort and say, “Well we can no longer afford that.” But that’s simplistic and misleading. We DID afford it. What led to the change in the deal was the staflationary 1970, which was driven both by a commodity prices (most notably the oil crisis) AND labor baragaining power (workers were able to demand that wages keep pace with inflation, which when inflation got beyond a modest level, meant it started to become self-reinforcing).

So the new program was to reduce workers’ bargaining power, both by combating unions, and by tolerating un and underemployment. Rising worker wages had been seen as crucial to greater prosperity; it was quietly abandoned as a policy goal. But this has profound implications. As rising income inequality demonstrates, the benefits of growth accrued substantially to those at the very top. But absent a few wastrels, people with that level of income are not going to spend as much of their income on consumption as those less well off. Thus (in very crude terms) Keynes’ problem of the paradox of thrift, that the understandable desire of households to save can result in insufficient demand, becomes even more acute when it it pretty much only the rich who are getting richer.

In this post I’m going to cast my net a little more broadly than Yves has and reflect on the demographic, social, economic, and policy changes that have brought us to the position at which we now find ourselves. Please don’t construe these remarks as either approving or disapproving of anything in particular. I’m just going to tell a story about what I think has happened.

The demographic, social, economic, and policy changes that occurred between 1970 and 1986 and particularly those that occurred early on in that period have functioned synergistically to lower the marginal utility of labor. Since it’s easiest to characterize the demographic changes, I’ll start there.

From 1946 to 1964 the U. S. experienced an extraordinary bump in the birth rate, the Baby Boom. In the early 1960s the Baby Boomers began coming into the labor market and by the early 1970s the oldest Baby Boomers were entering their peak earning years. This had an impact on wages, employment, retail, and the cost of housing (more about that later). It’s no accident that real income per worker peaked around 1965.

This is a blog post not a doctoral dissertation so I can’t go into the details of death rates, retirements, and so on but suffice it to say that in the late 1960s and early 1970s the number of jobs created was insufficient for the number of people coming into the labor market, putting downwards pressure on wages.

There were also social factors that put downwards pressure on wages. Women, partially responding to the loss of wages by men who at that point were frequently the sole wage earners in the family, partially in response to changes in mores and technology, came into the labor force in unprecedented numbers. This put additional downwards pressure on wages.

Among the many economic developments that should be considered in determining how we arrived at this point, I’ll mention just two. While the number of people coming into the housing market rose sharply in the 1970s, the number of units available didn’t rise nearly as quickly. This may be because it’s cheaper to make a baby than it is to build a house, zoning, barriers to entry in the construction business, the availability of capital to builders, or any number of other reasons. Maybe just inelasticity. It’s not material to the point I’m making here. The net effect was to increase the price of houses sharply. This raised the investment potential of residential real estate, too, coincidentally putting more upwards pressure on demand. Racial and ethnic minorities probably played some part in the change, too.

The other economic development I wanted to mention was a re-balancing of the economy in favor of the healthcare system. In the mid-1970s healthcare providers raised their prices. The cost increases of that period can’t be explained by increased utilization, longer hours worked by physicians, greater efficiency, better results, or anything else. Healthcare providers charged more for the same services. I’ve produced the statistics demonstrating that time and again so I won’t do it again here.

That set the stage for the enormous growth in the healthcare sector since then. After about 1980 nearly all of the cost increases in healthcare can be explained on the basis of inflation alone. Unfortunately for the rest of the economy, most other sectors couldn’t give themselves the same cost of living adjustments.

Between about 1970 and 1986 there are so many policies that have created our economy as we know it know that I can’t hope to explore all of them in this format. I’ll just list a few in quick bullet fashion:

• Nixon’s wage and price controls
• The collapse of Bretton Woods (this wasn’t entirely a result of U. S. policy; the Germans played their part, too)
• Reduction and then elimination of tariffs
• The mid-1960s change in immigration policy
• The banking de-regulation that began in the mid-1970s
• The changes in tax policy in 1981 and 1986.

No consideration of the changes in policy that have influenced our economy would be complete without mentioning China’s abandoning of its official policy of autarky in 1979 in favor of a sort of one-way autarky, i.e. we’ll run trade surpluses with practically everybody. That coupled with China’s pegging of the yuan to the dollar in 1993 laid the foundation for the situation we have now in which the United States runs enormous fiscal deficits which China finances by buying Treasury bonds.

So, in answer to the question in the title, you don’t need to resort to some sort of plot against unions to explain what’s happened. Trade liberalization, demographics, social change, and China opening its doors have worked synergistically to put downwards pressure on wages for most people while technology has rendered capital more efficient, increasing the incomes of those who’ve been in a position to make the best of the situation, AKA the top 1% of income earners. Add to those factors the growth in income on the part of healthcare providers disproportionate to the increases of other professionals and you’ve got our economic situation in a nutshell.

One last footnote. Look up “Fordism” (mass employment, mass production, mass consumption, guided by a collaboration of Big Government, Big Labor, and Big Business) here. I’ve posted on the subject a number of times. It’s collapsing everywhere. Today’s globalized world is too varied and too complex to be guided successfully by wise, capable technocrats.