The Map and the Territory

by Alan Greenspan

  GLOBALIZATION

  Among the most important was globalization in its many manifestations. As the rest of the world recovered, imports of goods and services into the United States exerted ever-increasing pressure on middle income American jobs, particularly union jobs. The share of our private sector workforce belonging to unions declined, from around 35 percent in the 1950s to 7 percent in 2012. Strikes or threats of strike—labor’s most formidable tool of the 1950s—rapidly diminished. In 2012, the number of workers on strike was less than one tenth of the average number that “hit the bricks” throughout the 1950s. Union wage premiums over nonunion wages, as a consequence, have virtually disappeared in recent decades.8 The Gini coefficient’s dramatic rise starting in the 1970s reflected in part the diminishing clout of labor unions.

  But while China’s gradual displacement of American jobs grabbed the headlines, an increasing number of “superearners” burst onto the international scene, adding upward pressure to the Gini coefficient. This trend was best illustrated by the Beatles’ emergence in the 1960s. The four mop-haired youngsters made a modest living in Liverpool, England. But it was only when they exploded on the global scene and were able to tap a vast international market for recordings and performances before large audiences that their incomes soared. Were it not for the global transportation and distribution at their disposal, they would have spent their careers in relative anonymity in Liverpool. Most important, however, was that the Beatles were not unique. They were joined at the top of the income distribution by prominent sports figures and other entertainment personalities. Without jet aircraft, these income outliers would have numbered far less.

  EDUCATION’S GINI

  Globalization’s superearner trend is even threatening to reach down to the area of our labor force least prone to income inequality—education. Teaching has been local and lecture audiences small. Salaries have reflected the economics of one on one or, at most, one on several hundred. But that is about to change. Superprofessors at some of our major universities have already gone online, reaching many thousands at a time. It is about to become a teaching world quite different from being bottled up in local classrooms. It may take awhile before such free lectures become sources of revenue for universities, with eventually much of that money ending up as incomes of the superprofessors, which would accordingly move up education’s Gini.

  STOCK PRICE DOMINATES

  But outranking globalization and the superearners in importance as drivers of inequality has been the growth of stock price‒influenced incomes. Portfolio management and investment banking vie for the top-paying industries according to data from the Bureau of Labor Statistics (BLS). As can be seen in Exhibit 11.1, the correlation between the Gini coefficient and the ratio of the S&P 500 stock price index to the average hourly earnings of production workers is, unsurprisingly, quite significant as stock price gains have greatly outdistanced the rise in production worker wages, matching the pattern of the Gini coefficient. But what has invited the attention of headline writers in recent years is the extraordinary rise in chief executive officer (CEO) compensation, especially when compared with average production worker wage.9, 10 The rise in the ratio of stock prices to average nonexecutive wages over the past half century is reflected in the declining share of gross domestic income earned by nonexecutive workers compared with the share of those whose income relates importantly to capital income—dividends, interest, rent, stock option grants, and capital gains (although the last is not included in the calculation of the Gini coefficient). Compensation data clearly show that the value of a CEO’s total compensation package is closely tied to the aggregate market value of the firm.11

  Having served on fifteen boards in the quarter century prior to joining the Fed, often on the boards’ compensation committees, I observed firsthand how the system worked. “Directors who determine executive salaries argue,” I wrote in 2007,12 “that key decisions by CEOs leverage vast amounts of [a company’s] market value. In global markets, the difference between a right move and an almost right move might represent hundreds of millions of dollars, whereas a generation ago, when the playing field was much smaller, the difference would have been in the tens of millions. Boards reflecting this view feel pressed by competition to seek the ‘very best’ CEO, and are obviously willing to pay what it takes to acquire the ‘stars.’” I should have added that second-best choices were available at a lower package of compensation, but the reason they are second best is that their average success rate has been a shade lower than the top pick. But given the aggregate market size of the average large firm, the implication of that higher success rate, more often than not, readily swamps the pay differential required to get top tier talent. I would be remiss if I did not point out that decisions of boards of directors do not always follow “best practice.” I discuss my experiences on boards, which were not always pleasant, in The Age of Turbulence (pages 423–36).

  I have not joined any boards since I left the Federal Reserve, but while it appears that the authoritarian power of CEOs that I observed for a quarter century (from 1962 to 1987) prior to my Fed tenure has markedly diminished, an increasing number of major companies are becoming quasi-“government-sponsored enterprises.” The quality of governance, if anything, has deteriorated as a consequence. If not reversed, the growth in the quality of our workforce will start to slow.

  THE SCHOOLING ECHO

  At the end of World War II, the skills conveyed by American educational institutions were extolled throughout the world. Students from all over the globe prized coming to the United States for an education they believed they could not get at home. Our university degrees were avidly sought, and indeed that remains largely true to this day. But our primary and secondary education systems have lagged. The 1995 Trends in International Mathematics and Science Study (TIMSS) reported data on the global status of American students that came as a shock. It and comparable measures of the shortfalls of our K-12 education system prodded changes that, apparently, have improved student performance somewhat in recent years.

  But is the echo of deteriorating schooling two decades ago as yet evident in the income-earning capabilities of those educated in that environment? Now, almost fifteen years later, we would expect some evidence of deteriorating quality of education being exhibited in a slower pace of economic performance, most specifically in productivity and its marginal proxy, real incomes. The data, however, exhibit no such trend. The ratios of income for households headed by fifteen- to twenty-four-year-olds to those headed by thirty-five- to forty-four-year-olds and those headed by forty-five- to fifty-four-year-olds remain stable through 2011. This suggests that education failures may yet turn up in deteriorating performance on the part of our workforce, and I must admit it is hard to imagine otherwise. But the evidence is not yet convincing, suggesting that other areas of economic distortions are at the root of income inequality.

  JOB MARKET IMBALANCE AND THE H-1B SUBSIDY

  This, however, does not mean that there is no distortion in the overall labor force. Many employers report difficulty in hiring the job skills they need, and indeed that concern is mirrored in the ratio of recent job openings to new hires, which in March 2013 was as high as it was in 2007, a period when labor markets were far tighter and all categories of workers were in short supply. This suggests that the skill structure of the workforce overall does not match the needs implied by the complexity of our capital infrastructure, most specifically in areas of high-tech industry.

  One area of economic policy that has received far less attention than it should is immigration reform. It is more likely than most policy issues to stabilize income inequality by opening up our skilled labor force requirements to the large pool of skilled workers abroad who show significant willingness to fill in our gaps in skills and, most important, at a significantly lower pay level. The barrier is clearly the H-1B immigration restrictions that protect (and subsidize) our high-income earners from the pressures of global wage competition
.

  As I noted earlier, the share of GDP that accrues to finance and insurance has more than tripled since the end of World War II (from 2.4 percent in 1947 to 7.9 percent in 2012). These jobs today are among the highest paid in the nation, in part because they are protected by immigration quotas that restrict entry of competitors who, were they allowed, would press such compensation and the Gini coefficient lower. Demand for visas for skilled workers (H-1Bs) “has exceeded supply every year since 2003, when,” as the Economist noted, “Congress slashed the number of visas on offer by two-thirds.” Compounding the problem posed by numerical limits on employment-based visas and green cards, employers are disincentivized to pursue skilled foreigners in the first place, owing to a lengthy and expensive process required to “show that they have tried and failed to find a suitable American for the post.”13 It is difficult to overemphasize the importance of long overdue reform.

  IN SUMMARY

  The degree of income inequality comes down primarily to the battle between asset values and the wage levels of the bulk of our workforce. Growing inequality can be viewed as the outcome of the shares of gross domestic income captured in competitive markets by labor and capital. In the early years following World War II, labor was dominant. With the rest of the world barely recovering, import competition was rarely seen. The power to strike and shut down a company gave labor the edge at the bargaining table. The world began to change when the lowly West German Volkswagen, a small and inexpensive car, first came to our shores in volumes. American car making was heavily concentrated in big powerful cars of the time and did not seem to need to worry about small, seemingly niche markets.

  But an even more telling blow to American global market hegemony was the devastating 1959 strike that shut down the American steel industry for 116 days. Domestic steel users, previously shunning imported steel products as inferior, were forced to finally try them. Steel buyers, as I recall, were pleasantly surprised at the quality of the steels that came from abroad to fill the void. It was the beginning of the end of America’s vaunted unrivaled supremacy in the postwar world steel market. The American Iron and Steel Institute (AISI) switched from being a strong supporter of free trade (the United States was a large exporter of steel) to a proponent of a “control imports” policy. I sadly recall when the AISI approached Townsend-Greenspan to help them in their lobbying strategy. We declined. We had ten major steel companies as clients at the time. I saw the handwriting on the wall and began to diversify my company’s client base.

  Globalization was mounting, as were our imports. We slipped from producing nearly half the world’s GDP immediately after the war to averaging less than 30 percent since 1980. Imports of goods rose from 2.5 percent of GDP in 1947 to 14.6 percent in 2012 (Exhibit 11.2). Labor unions’ share of the workforce began to decline. Strike activity fell off rapidly. The share of national income going to corporate profits, after trending downward since the postwar years, began to trend upward in the early 1980s—and stock prices followed. With that rise came increased income inequality. That trend continued until the onset of crisis in 2008. The decidedly probusiness environment before 2008 was nurtured by euphoric booms in quick succession between 1993 and 2006. Political opposition to the probusiness environment was muted.

  What can be done to end and possibly reverse the society-wrenching rise in income inequality? Having the United States withdraw from global competition is a nonstarter. It would succeed only in reducing the overall level of economic activity, both here and abroad. It would threaten the status of the dollar as the still undisputed world reserve currency. Similarly, constraining the secular rise in stock prices and the ratio of capital stock to labor input would have a similar effect. Taxation of upper income groups is limited. By 2009, according to the CBO, already more than 94 percent of individual income tax liabilities were levied on the top 20 percent of household income earners, up from 65 percent in 1979.

  SEQUESTERS

  But the onset of crisis created a deep schism between Democrats and Republicans, leading to the most recent “fiscal cliffs,” inadvertent sequesters, and a general breakdown in necessary legislative cooperation.

  This breakdown appears to have resulted indirectly from the half century of a near 10 percent annual rate of increase in social benefits under the sanction of both major political parties and, since 2001, tax cuts that eliminated the fiscal flexibility that historically had been essential to fund budget solutions acceptable to all parties.

  As I noted in Chapter 9, the rise in benefits has crowded out capital investment at a virtual dollar-for-dollar rate that, in turn, has significantly lessened our rate of economic growth. The unintended and ironic consequence has been a suppression of our capacity to fund future social programs. In retrospect, I have concluded that had we grown those benefit programs in line with the growth of nominal GDP since 1965 (6.8 percent per year), rather than at an actual annual rate of 9.4 percent,14 we would have advanced social welfare goals, albeit more slowly than contemplated, but without undermining America’s growth engine, arguably the ultimate source of social benefits.

  TWENTY-TWENTY

  Retrospection, of course, is always twenty-twenty. As I reminisced in Chapter 9, in the early 1960s fiscal policy was perceived as too structurally tight, engendering “fiscal drag” that was believed to be limiting economic growth. I do not recall any worries of overdoing the policy remedy: tax decreases and spending increases. In fact, federal government net savings remained in surplus between 1959 and 1966. We failed, however, to fully recognize the contractionary effect of benefit programs on gross domestic savings and, as a consequence, on economic growth.

  That growth slowdown of the last half century has left us with much less room for further expansion of entitlements, especially given the limits to further retrenchment in discretionary spending programs. Reversing our current direction is clearly economically feasible. Unless we do so, we will be risking another wrenching financial crisis. The size of our fiscal problem is reflected in the dramatic rise in the proportion of spending that has been borrowed in recent years rather than funded with taxes. That proportion had risen from zero in fiscal year 2001 to 45 percent in early 2010, and was a still problematic one fifth in 2013.

  Even bringing deficits down to a level that only stabilizes the debt-to-GDP ratio implies a permanent slowing of spending and/or a major rise in revenues from current levels. Political constituencies have gotten used to not only a certain flow of new benefits but also a continued expansion of existing benefits as well. Many of those in Congress who are constantly pressing for tax cuts are confronted with the inconvenient fact of having already sanctioned the benefit surge that now has to be financed.

  A TURNAROUND

  As difficult as it may appear, a turnaround of policy of the magnitude required has ample historic precedent. For example, Sweden’s highly praised welfare state ran into a crisis in 1990 and has since initiated a major reversal of course. Government’s share of GDP declined markedly from 1993 to 2012. Sweden brought its government accounts into balance. Its economy became competitive. They know there is still much to be done, but the Economist, following an extensive analysis of Sweden’s and other Scandinavian economies’ revival, concluded, “The world will be studying the Nordic model for years to come.”15

  The performance of the Scandinavian countries is by no means unique in demonstrating the incredible power of market competition. China, scarcely to be compared with democratic Sweden, nonetheless has demonstrated the remarkable economically recuperative powers of deregulating markets and allowing competition to flourish. And one cannot but admire the extraordinary tenacity of Margaret Thatcher, who lifted Britain from its malaise in the 1980s.

  Regrettably, since 2009, the United States has been moving in the opposite direction. Our expansionary policy response to the 2008 crisis failed to restore precrisis growth for reasons I raised in Chapter 7. The Dodd-Frank Wall Street Reform and Consumer Protection Act enacted July 21, 2010, h
as created a pall of uncertainty over financial markets (see Chapter 5). There is no doubt that the euphoria driving the dot-com and housing bubbles bred much fraud, much of which, I suspect, to date, has gone undetected. We will never be able to fully prevent such wrongdoing. Its malignant roots are too deeply embedded in our nature.16 So is our inbred sense of justice in seeking to punish wrongdoers. But regulatory punishment of bubble malfeasance, beyond proven criminal fraud, which of course should be vigorously prosecuted, does little to restore our economy to where we would like it to be. Revenge may be soul satisfying, but it is rarely economically productive.

  COMPETITION

  The fundamental driver of capitalism is competition. The unbroken line of success of China in recent decades, the so-called Asian Tigers a generation earlier, and West Germany coming out of World War II have all been predominantly the result of removing impediments to competition. The great contribution of the classical economists—Adam Smith and his followers—was to show how supply and demand interact to form a price system that directs resources to the needs most valued by consumers. To be sure, the proofs of these economic principles were in the context of individuals acting in their own long-term self-interest. Nobody, in the late eighteenth century or ever since, has fully believed that assumption, but nonetheless we conclude that it is close enough to the real world for these economically novel eighteenth-century paradigms to be credible.

  ELASTICITY

  Freedom of entry to markets creates high elasticity of supply (where a small price increase induces large increases in supply). High elasticity of supply thwarts monopolies (single sellers).17 A loss of market power of individual sellers enhances the ability of markets to set prices that achieve the mix of production of goods and services most desired by consumers.