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Growth and InequalityTerm Paper

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Growth & Inequality

While the United States has continued to see strong economic growth in the past thirty years, it has not seen strong wage growth, and the result is that the nation is presently struggling with a level of inequality that is much higher than it was in the middle of the 20th century. By 2013, the median wealth of middle class households in the U.S. had dropped by 20% (Weissman, 2014). If the trend is alarming, the response to it -- or lack thereof -- is even more alarming. Instead of using the policy tools at their disposal, including a wealth of economic analysis, politicians instead continue to favor the same policies that create this inequality, and many actively work to make it worse.

The Turning Point

Several articles have been written recently about the turning point, when the decline of the middle class began and American drifted towards the current era of inequality. It is known that the rise of labor unions and the development of a social safety net in the 1930s precipitated the rise of the middle class, assisted by a period of strong, steady economic growth. The growth itself was driven not only by increasing wealth among everyday Americans, but also by technological changes, a growing population, and a prolonged period of stability, foreign wars confined to Asia, away from America's markets.

It has been argued on a number of fronts that, at the forefront of this time of equality were the labor unions in the automotive industry -- that UAW contracts set the tone for unionized workers across the country, with non-unionized workers following suit. Zucker (2014) found that there was a correlation between union strength, and equality among Americans, and that indeed auto workers' unions were at the fore of influencing this wealth. When the autoworkers' unions lost their power -- the result of eroding market share following the oil crisis -- this weakened unions everywhere. Today, unionization is at low rates across America, and the result is that workers have little bargaining power. This is straight economics -- an individual worker, unless possessing a highly-differentiated skill set, has little bargaining power, because substitution costs for the employer are relatively low. In economic terms, we know that pure competition results in no profit -- if we have pure competition in labor markets the result is more economically efficient but there is no opportunity to take profit.

When workers cannot take economic profit, this means that they will earn just enough to meet their basic needs. For unskilled workers, this appear to be the case today. For workers with some sort of skills, there remains some ability to earn economic profit in labor markets, but with the amount of opportunity for education in the country, it takes a lot of education or high-end skill in a trade in order to genuinely be differentiated from the thousands of potential competitors. Without collective bargaining, workers are left to the economic reality that for all except those who have truly differentiated skills, it is a buyer's market.

What has happened since unions began to lose their power in the 1970s is predictable even with rudimentary economic models. There are, however, other factors at work. If America achieved equality on the basis of numerous programs and protections that made it difficult for a working American to fall into a state of poverty, the steady erosion of these protections has reversed that trend. Minimum wages have not kept up with inflation. More women have entered the workforce, increasing competition, and waves of new immigrants only increases competition further. More competition, naturally, means less opportunity to differentiate. Other issues, such as the passage of Gramm-Leach-Billey, eroding restrictions on speculation, have allowed the very rich to increase their accumulation of wealth. Studies have revealed that federal politicians in particular do not reflect the interests of the middle class at all in the policies they support -- only the wealthy genuinely have any political power in the U.S. (Drum, 2011).

But the reality is that while one can decry giving the very wealthy more opportunities, the bigger issue is not that the wealthy are getting more wealthy; it is that the middle class is gradually slipping into poverty in America. If the middle class was still strong, nobody would care about what the billionaires were doing.

The decline in union power, while oft-cited, is just the most visible cause of growing inequality in America. Studies estimate the impact of declining union power on growing inequality from 20-33% (Kristof, 2015). Legal changes are not entirely to blame, either -- inequality is a significant problem in the UK and Canada (Hills, 2013; Brzozowski, et al., 2009). Some of the issues are indeed bigger, and can be explained by applying both microeconomic and macroeconomic principles to an understanding of where wealth creation and distribution comes from.

The Growth Story

First, a note about the economic growth story. Since the early 1990 and the peak of union power, the U.S. economy has generally been on an upward trend, with an annualized growth rate of 4.17%, according to IMF data (Knoema, 2015). Despite an economy that improved steadily, U.S. workers were not the beneficiaries of this growth. The average hourly wage in the U.S., seasonally adjusted, has increased since 1964 from $19.18 to $20.67 in today's dollars (DeSilver, 2014). That is an increase of 7.7%, far less than the increase in the GDP. Even the most regressive of tax policies cannot create such stagnation, and as noted that same stagnation occurs in other countries, which raises the possibility of explanatory factors that are bigger than just the United States. There is no doubt that some inequality is domestic, but it is worth considering that the entire global economy has changed since the early 1970s.


The power of the unions began to falter when Americans started buying foreign cars. In the early 1970s, the market share for the big U.S. automakers was around 98%. The oil crisis caused many to rethink their land yachts, and start buying smaller cars. The short version of the story is that U.S. automakers rejected this trend, and as a consequence foreign automakers were able to build their share in the U.S. market. As the big automakers lost market share, they were forced to cut workers, something that inherently weakened the labor movement overall. The labor movement came under other attacks as well, vilified for internal corruption and scandals, as well as headline-grabbing examples of excess. The narrative around unions changed, but the reality is that union jobs were starting to disappear anyway.

The U.S. has been at the forefront of globalization, the process by which improvements in technology, transportation and communication have brought the world closer together. The U.S. signed a landmark free trade agreement with Canada, then a few years later added Mexico to form NAFTA. After this, the World Trade Organization was created. All of this activity sought to create a world with fewer barriers to trade. This flows from some rather basic economic principles. The first is that barriers are an impediment to economic efficiency. By removing the barriers to trade, thereby lowering transaction costs, global trade would become more egalitarian, and ultimately would result in a growing economy for any nation that participated in this global trade regime. This is especially true of countries well situated to take advantage of liberalized trade, and the U.S. is certainly among those. As predicted by the most basic of Ricardian trade models, global trade has skyrocketed since the process of removing trade barriers began in earnest. Thus, wealth has been created with more efficiency than ever before.

Now, the theory of comparative advantage holds that as more wealth is created, it will be distributed among the nations that participate in the system. The U.S. has enjoyed wealth, but the wealth creation mechanisms in free trade regimes funnel that wealth through corporations, and the beneficiaries of increases in corporate wealth tend to be the wealthy. That is certainly the case when there is a strong and ongoing reduction in worker bargaining power.

Worker bargaining power was reduced in several ways, not all tied to the weakening of labor unions. More women are in the workforce than ever before. While this raises household incomes, it also creates competition for jobs. Immigration has brought more competition. On average, more workers means a bigger, stronger economy. Per capita, that is not necessarily the case. More competition for jobs reduces bargaining power of those seeking work. But the biggest threats to the bargaining power of American workers are not the new additions to the domestic labor force, but other countries. The liberalization of trade implies, as a matter of principle, that a country once dependent primarily on its own production is going able to import more goods. Since many nations had a competitive advantage in the U.S., especially in labor costs but also in land costs and regulatory costs, the U.S. manufacturing industry has… [END OF PREVIEW]

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