The Economics of Wreckage, Part Two
Sustained, robust economic growth is a key goal of modern policymakers both in Washington and in state capitols. Recent articles have highlighted, somewhat to the consternation of President Bush's critics, what has apparently been surprisingly strong growth during much of his Presidency. Right-wing explanations master George Will, writing in a June 10, 2007, op-ed piece for the Washington Post, crowed about "65 months... of uninterrupted growth," among other breath-taking economic performance numbers. Over a much longer term than Mr. Will described, given his interest in focusing attention on his favored politician, the real (that is, inflation-adjusted) economy of the United States has grown with barely a pause, as can be seen in the simple graphic below, drawn from real GDP data provided by the St. Louis Federal Reserve.
But that remarkable run of sustained economic expansion strikes many as profoundly contrary to the course their own economic circumstances have taken over the past several decades. Writing at Debswebwith a cross-post of her article at Big Brass Blogblogger Debra tore into Mr. Will:
Oh George, please stop trying to pull the wool over our eyes. In the eighties I made more money than I do now and I had benefits. In the nineties I made minimum wage while studying for my Masters and was able to live on it. Not very well but I could survive and still go to the movies. Now I have said Masters and make more than minimum wage but I can't pay all my bills and I certainly can't attend the movies because the price of the ticket is ridiculously high. I can honestly say that the only thing that has increased in the last 25 years is my level of debt and my inability to pay it off. It isn't that I'm still paying for a meal that I ate in 1989, I'm paying for the schooling that was supposed to improve my ability to earn money but is instead an anchor pulling me to the bottom of the debt sea.Indeed, Debra hit squarely on one of several curious features of the economic wonder of the past two-and-a-half decades: while the economy has grown with only modest and rare recessionary downturns, the living standards of millions and millions of American households have eroded, and they have done so noticeably, certainly to the occupants of those households, who know very well that they were living better earlier in their lives, and they were doing so without incurring a mounting pile of debt.
The graphic below, drawn from Household Debt Service and Financial Obligations Ratios data provided by the Federal Reserve Board, shows the legacy of rising monthly total debt service obligation under which Americans have been laboring in the modern era.
The sense among so many of losing economic ground is given quantitative evidence in the graphic below, derived from average annual hourly earnings data provided by the Bureau of Labor Statistics and consumer price indices offered by the Minnesota Federal Reserve. It shows that, while "nominal" hourly wagesthe wages workers see, with no correction for inflationhave risen steadily for a very long time, real wages (wages corrected for the purchasing power erosion of inflation) have been pretty much stagnant.
The two visual depictions above, taken together, go a long way toward explaining the feeling among many Americans that their shared economic situation has been deteriorating: purchasing power has gone nowhere, but the percentage of that stagnant purchasing power committed to paying fixed bills every month has gone up and up.
The graphic below depicts more strikingly, if a bit more complexly, the difference in changes in real and nominal wages that have been going on. It shows not the levels of real and nominal wages, but how those real and nominal wages have changed as percentages from one year to the next over the past several decades.
Note in particular in the graphic above how the year-to-year percentage changes in real average hourly wages have pretty much canceled each other out over a long period of time, meandering with a seeming aimlessness around the zero-percent axis.
How could it be that the labor force propelling an economy to ever-greater real value would not share in that expanding pool of value? Is this evidence of the Marxist description of the controllers of capital systematically expropriating the fruits of labor from those who render it; or is it perhaps some late-20th Century plot whereby the government has participated in an alliance with the wealthy to ensure a more and more unequal distribution of income to the end of destroying the ability of average citizens to live their lives independent of some over-arching government entity providing all their needs for them?
Such possibilities must be left to those more attuned to the nuances of conspiracy theories and all the many forms and supposed proofs thereof. Practically speaking, the explanation is somewhat simpler, although perhaps no less troubling; but a few background terms and concepts must first be set forth.
"Factors of production" are the things needed to turn raw materials into final products. At least for pedagogic purposes, there are five: land, labor, human capital, physical capital, and entrepreneurial skill.
Land is the physical platform on which production occurs. Although extraordinary counter-examples might exist, virtually all production needs at least some land. It could be a lot, as in acres and acres on which are located horizontal assembly line factories; or it could be just enough on which to put a computer and a Webmaster to publish a backwater blog about economics.
Labor is brute human force, the kind of animal energy that simply moves physical objects. Often, the word "labor" is used broadly to encompass another factor listed above, human capital; but technically speaking, the two are different.
Human capital is the transformed, refined, developed, educated result of labor resulting from its natural (and, to some extent, entirely unconscious) tendency for improvement. Labor is always on the move to becoming human capital, whether it be through on-the-job learning, through personal trial-and-error development, or through education in school. Certainly, however, in most expositions the word "labor" includes the improved production factor technically defined as "human capital," and there's nothing wrong with that blurring of the distinction unless it becomes an unintended veil that hides an erosion of compensation to workers when their productivity is improving through their transformation of labor skills into human capital skills.
Physical capital is buildings, equipment, machinery, computers, telecommunications equipment, and all the other inanimate objects that are used in production.
Entrepreneurial skill is the factor of production characteristic of market economies or sub-economies. It is the factor of production that willingly (or perhaps unknowingly) bears risk for an expected reward by bringing together the other factors of production and combining them in such a way that some output is created.
So much for the factors of production. The next set of principles and definitions has to do with the paper used as a store of value, a medium of exchange, and a unit of account, as those features were set forth in Part 1 of "A Brief Story of Money" published here at The Dark Wraith Forums.
With respect to the matter of inflation and money, a rock-solid principle of economics is that inflation will necessarily result when the growth rate of the money supply exceeds the real growth rate of the economy. Inflation is not "caused" by money-grubbing merchants "jacking up their prices"; inflation is not caused by soul-depleted capitalists extracting larger and larger profits at the expense of consumers and workers; inflation is not caused by greedy unions demanding and then getting huge wage increases; and inflation is not caused by raising the minimum wage.
Not one of those things can cause inflation, which is defined as an increase in the aggregate (the "overall") price level. Any sector of the economy that tries to extract higher prices, be they for final goods or as rewards to one productive factor or another, can do so only to the pricing detriment of some other sector, unless too much money has been put into the system thereby allowing one sector to draw higher prices without others having to reduce their prices.
It is just about as simple as that. It might look very much like a price or wage increase has "caused" inflation, but that's only because the increase allowed the already over-printed money to express its presence through the aggregate price level. The rule, then, is straight-forward: when the growth rate of the money supply exceeds the real (physical) growth rate of the economy, in the long run, inflation will result. Part 2 of the series, "A Brief Story of Money" explained exactly how over-printing of money becomes inflation and provided a simple formula called the "equation of exchange" that mathematically captures the relationship among the critical factors, which are the size of the standing money supply, its velocity (how many times the money supply "turns over" per period in an economy), the aggregate price level, and the real output level of an economy.
Having stated the long-run consequence of over-printing money, it is crucial to point out that, in the short run, a money growth "overhang" can cause a punch of real economic stimulus, as was demonstrated in the aforementioned second part of "A Brief Story of Money." One necessary condition for this surge in real output to occur is that at least one factor of productionand it has to be a major factorhas to be incapable of capturing its share of the inflationary price spiral being caused by the money overhang. Such a factor unable to move its reward upward would be forced to create more real output to earn enough to pay the higher prices of everything else.
Guess what factor of production has historically borne this burden.
That's right: labor. As long as the growth of wages and salaries lags behind the inflation rate for everything else, workers have to work harder (more hours and at greater and greater productivity) to be able to maintain their established consumption patterns.
A persistent myth among the more well-informed students of economics has to do with the role of so-called "neo-Keynesian" economists of the last half of the 20th Century. John Maynard Keynes, the magnificent architect of the economics that inspired Franklin Roosevelt's New Deal, knew very well that wages were "sticky." This is a persistent phenomenon because of the nature of labor retention by the businesses that hire workers. No worker's wage is adjusted on a day-by-day basis, and virtually no worker can instantly shift employment to capture a better wage if his or her present employer refuses to adjust wages to prevailing price conditions and labor demand. In plain terms, workers are stuck, at least in the short term, in the jobs they're in; as such, they are stuck with the pay they've already negotiated until such time as they can either renegotiate through a normal contract renewal or through expending time and money in search of a better compensation package, if one even exists.
Neo-Keynesians, among the most notable of them such luminaries as John Kenneth Galbraith, envisioned a partnership of government and industry (perhaps what Eisenhower warned about as the infamous "military-industrial complex") that could keep a huge economy like that of the United States growing at an aggressive rate through fiscal policy intervention that might of necessity have periodic shots of overproduction of money. Notwithstanding Dr. Galbraith's claim that large unions would provide one aspect of a countervailing force against industrial economic and political power, this model simply cannot use over-production of money in its inventory of macroeconomic stimulators if unions were persistently powerful enough to keep wages rising in lock-step with other prices. Powerful, effective unions (in particular, the industrial ones) pose a show-stopping threat to the success of monetary economic stimulus because they have the potential to force wages to move at nearly the same growth rate, in nearly the same time frame as other prices (both final and factor), thereby absorbing for labor a "fair share" of the excess money being printed. Such a situation would wreck the way the over-printing of money could lead to actual, real growth of the economy, since it is only if wages and salaries are "sticky" that labor is forced to work more and harder to handle the price shocks pushing everything people buy upward.
The graphic below shows the nominal effect in terms of year-over-year percentage changes in the nominal average hourly wage rate and the associated percentage changes in real GDP.
Upon careful inspection, the key feature reveals itself: nominal wage changes slide during the booms in real economic expansion, and then those nominal wage changes begin to capture better increases just in time for the Federal Reserve to clamp down on the money supply, throwing the economy into a downturn with layoffs and unemployment, thereby suppressing the nascent upsurge in nominal wages. In other words, when the American economy is in a growth phase, that's the most likely time the wages people are getting (their nominal, or "apparent" wages) are unable to capture their share of the growth. It's only when the booms are petering out that wages begin to get "unstuck," and by then, purchasing power erosion has already permanently corroded real living standards, thus pushing upon the workers in their consumption mode the incentive to draw higher debt loads to compensate.
Neo-Keynesians are not now, nor have they ever been, fools: they know very well, as do others, that Keynesian-style government intervention would have no real effect were the vast majority of well-paid workers to keep wages moving in rigid lock-step with other prices.
The same goes for the politics of the minimum wage, which cannot be raised very frequently, and certainly not one-for-one with true inflation, if over-production of money is to cause real economic growth. Minimum wage workers, like their better-paid union and middle-class white-collar brethren, must face an aggregate (overall) price level that is going up faster than their wages are, since "losing ground to inflation" will force them to work more hours and induce them to increase productivity in an effort to move to a higher wage bracket.
Were the minimum wage to rise in lock-stepsay, month by month or even quarter by quarterwith the government-published consumer price index, the lowest-paid workers in this country would not have to work more hours and with greater productivity as other prices were rising because of the over-printing of money. Timely indexing of the minimum wage would defeat the whole purpose of government macroeconomic intervention, which in its correct design is to the purpose of generating real economic growth.
It is one of the great and continuing follies of business shills to claim that raising the minimum wage is "inflationary." In fact, the only thing that can cause inflation is printing money at a rate in excess of the real growth rate of the economy; all that happens if the minimum wage is raised is that the previous over-printing of greenbacks gets expressed fully throughout the matrix of productive factors instead of being restricted to only those under the direct control, and to the direct benefit, of business interests and the wealthy who can impose willful price rises through market power. This same rule applies to union wages, too: no inflation that was not already pending in the economy arises because of a new bargaining agreement that gives members a wage increase somewhere near the rate of inflation. In fact, no inflation not already seething below the surface would be "created" even if there were some extra compensation, because that component could very well be nothing more than a proactive payment for the expectation that prices will rise faster because wages are about to reflect labor's share of excessive growth of the money supply.
To claim that raising the statutory minimum or any other wage is "inflationary" is getting cause and effect exactly reversed. The inflation is already there; and to the extent that labor does not or cannot capture its share of the erosion of purchasing power with better pay, the economy experiences less inflation, but that's only because it is wages and salaries not moving upward quickly enough that keeps inflation from rising at the rate it otherwise would, given the rate at which money is being printed excessively.
As it is, wages and salaries really have been successfully and systematically suppressed over a long period of time, at least on average. This is arguably the principal reason the U.S. economy has grown so robustly in the post-World War II era.
The final graph, below, of this article shows the year-over-year percentage change in real GDP and real average hourly wages. It is remarkable for several reasons, one long-term, and one quite recent.
Note first in the graphic above how, over the course of the past two decades or so, changes in real average hourly wages have moved in general synchrony with changes in real GDP; but almost always, the wage movements came after the associated GDP movements. The changes in real wages are, in effect, an echo of the changes in real GDP. That's the "unsticking" of the wages, as labor finally gets a piece of the action after at least some of the other factors of production have gotten their respective shares. Notice also in this same regard that the percentage changes in real wages go more deeply into negative territory (that means actual losses in real purchasing power) and never go more positive than the correlated real GDP rise on the upsides. That's why the economy can grow in real terms, yet leave people feeling further and further behind, relatively speaking.
And finally, in the graph above there is a short-term phenomenon that should be noted. It happened in the last half-decade or so. The relationship between the two lines is starkly different from what it was before. Notice how the echo of real wages from real GDP is completely gone. In fact, if anything, real wages have become an inverse echo of real GDP during the presidency of George W. Bush!
But the President and his Republican allies in Congress have certainly been nothing if not hard-core neo-Keynesians. Wildly large federal deficits year over year to spend on massive wars and other gargantuan pork; huge tax cuts; and a Federal Reserve Board that, by its own admission, was "accommodative" until mid-2004 and perhaps remained so long after claiming to rein in its overproduction of money. Those are purely Keynesian and neo-Keynesian macroeconomic policy prescriptions for government intervention to make an economy grow.
So what happened to the neo-Keynesian real wage echo effect? It's gone; or, at the very least, it's occurring far later than it had in the past. Either way, the corrosive effect that was always part of the lag between real economic growth and wages has become stronger because that lag has become longer. Why the echo has become either inverted or more perilously delayed will be explained in a subsequent installment of this series.
The Dark Wraith will now allow some time for readers to absorb what has just been presented.
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