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.

8 comments… add one
  • steve Link

    We have disagreed a bit on the health care part of your equation before, so I will let it go, but otherwise I think you get a lot of this correct. 1980 seems to be the general center for when things changed that lead to our current crash. The foundations for those changes may have occurred earlier, things like the price controls and oil prices, but 1980 is the center of a critical period. To your list I would also add the strong dollar policy.

    To your list I would also add something a bit more philosophical. Maxine Udall has been writing about the disconnect between morals and market behavior. The way that we buy things has changed dramatically over the last 50-60 years. Markets used to serve the function of binding us together, of enforcing moral values. If you screwed your neighbors or did shoddy work, you lost money and were ostracized, run out of the county. As, she notes…

    “Markets then are places where more is exchanged than goods and services, labor and product, credit, and interest. They are places where we also develop the personal virtues of temperance and prudence and the social virtues of benevolence and justice. When they function well, they produce trust, loyalty, and sympathy among those who trade there.”

    We decided that since markets are good, so must be the people who work with them and run them. While there are still many fine people, especially in small business, who have a moral sense about what they do, it has disappeared in too many of our large corporations. Their CEOs never developed that sense. As Udall says later.

    “What does profit represent? Is it a return to the ability to dupe amateurs or is it a return to the ability to provide expert information about a product and to help amateurs to identify the product that best fits their preferences, their budget constraint, and their long-term goals?”

    Duping the amateurs has become too much of the norm. It was a big piece of this financial crisis we have now. I would bet that most of those big corporate guys now have grown up without the experience of the local market. At best, they may be amoral. If we continue to rely upon them to set their own internal limits, it wont happen.




  • Steve, I don’t disagree with your point that there’s something deeper involved but I might disagree with you on the timing. I had first-hand experience of the disconnect between morals and business behavior more than 30 years ago back in the 1970s. The very first company I ever worked for nearly 40 years ago ran into problems because it refused to pay kickbacks.

    I didn’t have firsthand experience of any moral dilemmas in the next company I worked for, a German company, part of the time in Germany. However, when I came back to the United States and went to work for a U. S. company within months I was in the middle of a purge that came about as a consequence of a regional manager putting water on the books.

    I attribute the change to a transition between the society we once had, based on internalized guilt, to what I see as the society we’re becoming, based on externalized shame. I see no way that democracy and a small-scale state can endure in a shame culture.

  • steve Link

    I hope I did not imply that we have never had bad behavior in the past. When businesses become larger, amoral/immoral behavior and its results become magnified. It appears to be more commonly accepted. I dont mean to sound like some cranky old guy saying things used to be better, but we have lost some of the institutions that would normally teach and reinforce moral behaviors. Loss of old fashioned markets and less direct interaction with small businesses (and their owners) seems like it could be a piece of the puzzle.


  • Drew Link

    “We decided that since markets are good, so must be the people who work with them and run them.”

    Udall sounds like an idiot. Who we, Keemosabe? First, I know I’ve never made that assumption, nor have any of the intellectual founders of free market theory that I know of. Rather, they acknowledge that people will behave in their own self interest (within a range of how nakedly) but rely on the reality of competition to temper actions. It seems to me its when competition is limited, or governmental bodies with narrow interests intervene, that market forces start to break down in their self correcting function.

    I think Dave has it far more correctly in his last paragraph, citing internalized guilt vs externalized shame. This is societal, not markets.

    Let’s look at sports: we have doping in cycling and baseball; a third of the NBA and NFL should be locked up in prison. And big time college sports is nothing more than slavery thinly cloaked, and constant chicanery. Yet all any of the participants have to do is hire a PR consultant, say they are sorry, and start collecting their millions again. And society tolerates it. Cause they like Christians and lions.

    Business? We have insulated so many businessmen from market realities, or set up government sponsored goals/dodges that have corrupted so many. To be sure, public company boards have been asleep at the wheel. But what about the housing debacle? Fannie, Freddie……….and this joke of a “Finance Reform Bill.” Market failure? No. Social failure. Crooked pols? – go to the camera, apologize, look contrite, perhaps let a tear slip……..and then get re-elected. Why? Cause the public thinks you are bringing home the bacon from that massive poker game going on in Washington, or a state capital etc. Social failure, not market.

    And lastly, steve – and I apologize in advance, but I just have to do this, its my direct nature – in an exchange here many posts ago you said that you were not concerned about fee capping that might result from the health care bill. You said your practice would find procedures to fill the gap revenue. Since you have no ability to control disease, the implication is obvious. Market failure or social failure?

  • The concept of a “Social Contract” is nonsense. You can’t have a contract where one side has the option force and coercion and the other side does not, at least according to the “contract” that was never really discussed by any of the people it applies too. Given the nonsensical starting position all follow on discussion is equally nonsensical.

    As for Yves Smith’s take on the 1970’s its stupid. It is stupid because it ignores the role of the Federal government and the Federal Reserve in trying to fine tune the economy via monetary policy and the Philips unemployment/employment trade off relationship. Basically our wise and glorious leaders at the time forgot that people don’t suffer from money illusion indefinitely and once they caught on the price increases were inflationary and not due to increased demand they stopped responding as if they were due to increased demand and the relationship between unemployment and inflation went vertical (i.e. higher levels of inflation had no impact unemployment, so when unemployment went up due to a recession and the Fed tried to reduce it via inflation, all they got was higher inflation).

    Were labor unions and oil prices a factor? Yeah, but of secondary importance IMO. They might have triggered a recession (oil prices) and made the situation more problematic in terms of rising prices (labor union contracts), but at the primary cause, nope.

  • “We decided that since markets are good, so must be the people who work with them and run them.”

    Udall may be an idiot, but she never said that. Note where the quote marks end in the original post, please. 🙂


  • steve Link

    “You said your practice would find procedures to fill the gap revenue. Since you have no ability to control disease, the implication is obvious. Market failure or social failure?”

    Actually, I said that doctors would find a way to do more procedures to fill the gap, not my group specifically. There are studies showing that if you put more doctors into a geographical area, they just find more stuff to do. You can always find a reason to do one more study or one more procedure. Economic incentive would abet those decisions, even if they are not conscious. There is a lot of gray in medicine. As to my specific group, we produce at the 65 th percentile and are paid at the 35th. We could make it up some by doing more cases where we are not actually needed, but we have resisted that so far.

    This does touch upon a topic I write about a bit. If you read through medical journals you will see ads by billing companies that claim they will come in and make sure you dont leave any money on the table. One of the dozens of reasons that medicine costs so much is that some docs are maximizing revenue, often by doing things which are not harmful to the patient, but optimize their own revenue while providing no better care. In that respect, I think some docs have lost a bit of that moral sense I am trying to write about above.

    Maxine-Sorry if I misinterpreted your piece, or misrepresented it. I should have quoted you more and typed less.


  • No problem, Steve. I think you did a great job for the most part. My remark was aimed at the fellow who called me an idiot. 🙂

Leave a Comment