Prior to the U.S. invasion of Iraq in March 2003, there was frenzied talk about WMDs — weapons of mass destruction. When it was later determined that Saddam Hussein possessed neither chemical nor nuclear weapons, the White House was furious at critics who wondered aloud if the entire WMD claim was actually a fabrication.
The Iraq invasion turned out to be a colossal mistake in terms of lost lives and heavy expenditures that sharply raised the federal budget deficit. However, few realize that the Bush administration made a far bigger miscalculation: They launched what you could call weapons of mass exploitation — WMEs — that have all but decimated the U.S. economy.
Think of these financial weapons as pain meds that never fix your underlying medical problem, but simply mask the symptoms until it may be too late for treatment. They seem to address the problems of unemployment and dwindling family incomes while putting our economy deeply in debt and making the rich richer. Most nations have deployed these WMEs, but various American administrations have been exceptionally adept at it.
Because these weapons get talked about in terms of “fiscal policy” and “monetary policy,” the public’s eyes glaze over. But if you stick with me through some pretty simple equations, the experts won’t be able to fool you anymore.
Let’s start with supply and demand — something you’ve probably heard of even if you never took a course in economics. Supply and demand are like the two wings of an airplane: They have to be strong and balanced, or the plane will crash.
What is the main source of supply? Productivity — the production of goods and services. What is the main source of demand? Wages. If you become more productive — through education or the use of better technology — you produce or supply more goods. If your wages rise, then you consume or demand more goods. In this case, we’re talking about the total value of goods produced and consumed nationally.
For the economy to stay healthy, supply must equal demand. That’s our first simple equation: Supply = Demand.
Because of investment and always-improving technology, productivity and supply rise year after year. This means that wages and demand must also rise in the same proportion, or there will be an imbalance in the economy. If wages trail productivity, then supply exceeds demand. Businesses are unable to sell all that they produce, and layoffs follow. Hence the only real cause of unemployment in an advanced economy is the widening of the gap between what you produce and what your employer pays you.
However, joblessness also creates problems for elected officials, because the unemployed have the right to vote. To stay in office, politicians have to find ways to raise national spending to the level of supply. They face two choices: Either institute policies that raise your salary proportionately to the level of your productivity — which is only fair and ethical, after all — or adopt measures that will lure you into larger debt so that you must spend more, not from a bigger paycheck but from increased borrowing.
Luring the public into debt in order to get re-elected, I believe, is crass corruption. It is also corruption because the politicians, ever in need of campaign donations, wouldn’t dream of offending business interests that push for low wages. With wages trailing productivity since 1981, elected officials have been following what is known as monetary policy, which tempts people into larger debts. This temporarily keeps unemployment under control. Spending can rise to the level of supply, because now: Supply = Demand + New Consumer Debt.
Under this policy, the Federal Reserve prints more money to bring down the interest rates and induce people to borrow more. However, the wage-productivity gap has been widening so fast that the government has also had to raise its own spending and debt constantly to keep the two sides in balance. So: Supply = Demand + New Consumer Debt + New Government Debt.
Raising government debt to postpone the problem of unemployment is called fiscal policy. Now you see why our nation is awash in debt at both the consumer and the government levels. Elected officials have frequently used debt creation to get re-elected, while creating the impression that they are doing American workers a favor by preserving their jobs. Are they doing you a favor? Absolutely not.
First, job creation occurs through the cooperative action of producers and consumers. Producers create supply and hire workers, but if their goods remain unsold they lose money and workers are laid off. You are doing your job of being productive, on the one hand, and creating demand out of your salary on the other. If your demand falls or does not rise enough, then it is because your boss has not given you a raise or has cut your wages. At the macro level, insufficient national demand only means that workers have produced so much that supply exceeds demand, so some people have to be laid off. Where then is your fault in this entire process?
Once the government has generated enough new debt to increase spending to the level of supply, the unemployed are called back to work, though usually at lower wages. In that case, overproduction vanishes and profits jump — but not into your pocket. If your wages and hence your demand are constant, then the entire increase in debt value goes into the pockets of suppliers. With the creation of new debt, all the producers’ goods are sold and profits soar, while your salary, at best, grows very little. So if wages stay low but the deficit increases by, say $1 trillion, then that $1 trillion is going into the bank accounts of business owners, not workers.
This is exactly what has occurred during the Great Recession that started at the end of 2007. Millions of people were fired because the likes of General Motors, IBM, Microsoft, and Goldman Sachs couldn’t sell all they had produced. Bush sharply raised the budget deficit, and the Federal Reserve printed tons of new money to bail out failing businesses. As a result, the economy stabilized in 2009 and began to grow in 2010.
However, real wages fell, while profits skyrocketed. Why? Because the entire increase in government debt went into the coffers of producers. This is how Goldman Sachs could give $20 billion in bonuses to its executives in 2009, while millions of people were being laid off.
What should we do about these policies that are enriching the rich while not doing much for the jobless? For the answer, look at the American economy in the 1950s and the 1960s, the golden decades of high growth and growing prosperity for all. Gross domestic product growth averaged over 4 percent a year. Real wages were rising to match productivity. The top-bracket income tax at the time averaged above 80 percent, and corporations paid 25 percent of the total tax revenue or about 5 percent of GDP. The middle class paid low taxes, and there was practically no budget deficit.
Why was GDP growth so high back then? The answer lies in high taxation of wealthy individuals and corporations. Thus, for the 1950s and the 1960s: Supply = Demand + Near-Zero New Debt.
Since real wages grew as fast as productivity, new debt was practically zero. People met their needs mostly out of their rising salaries. Demand rose in a natural way to match increasing supply. It may be noted that supply comes primarily from the rich, but demand comes primarily from the poor and the middle class. Since taxes were low on low-income groups, consumer demand grew as fast as salaries; but from 1981 on, thanks to President Reagan and his advisers such as Alan Greenspan, the tax burden was transferred from the rich to everyone else. Income tax rates sank for wealthy individuals and corporations, while most, if not all, other federal taxes jumped. The self-employed small-business person, for instance, saw a rise of 66 percent in tax rates. The crippling tax burden on lower incomes naturally reduced the growth in demand, so GDP growth fell sharply below that of the 1950s and ’60s.
All this suggests that we should move toward the tax structure of the 1950s and 1960s. Today the top-bracket income tax rate is 35 percent. Suppose we were to raise this rate to 45 percent for annual incomes above $250,000 and to 70 percent for incomes above $1 million. The income tax yield would rise from $1 trillion to $1.5 trillion. That still leaves high-income tax rates well below those of the 1960s. If we went back to the old tax rate of 45 percent on corporate profits, while eliminating loopholes, that would bring in extra revenue of $600 billion. Thus higher taxes on affluent families and businesses would raise our revenue annually by $1.1 trillion. This way we can almost eliminate our budget deficit, which is currently running at an annual rate of $1.2 trillion.
Eliminating the deficit would quickly revive our comatose economy. An early benefit: Our trade deficit would fall, especially with China, our foremost lender. China would not be able to use its surplus dollars to buy more U.S. government bonds, and our manufacturing would revive. Thousands of new jobs would be created, raising tax revenue further.
The next step would be to reduce the tax burden on lower incomes by cutting the self-employment tax from 15 to 12 percent. We could also eliminate the Social Security tax on the minimum wage. Our increased tax revenue would pay for these cuts, which would further raise consumer demand and hence GDP growth. Note that the trade deficit is also a WME, because it tends to lower wages while stuffing the wallets of the CEOs of multinational corporations.
Another WME that our government has systematically used to reduce our living standard is outsourcing. A stiff tax on this practice would raise even more revenue and enable us to trim the tax burden of low-income groups.
In short, the American economy could be easily fixed if our government would stop using its vast arsenal of WMEs against us. I believe that in just 12 to 18 months we could bring the nation back to an unemployment rate of 6 percent, which is close to full employment.
All it takes is politicians with courage and the ability to understand a few simple equations.
Dr. Ravi Batra, an author and a professor of economics at Southern Methodist University, can be reached at ravibatra.com.