Economics, politics and the reality of the 'squeezed middle'

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Are we catching the US disease?

The average American household has failed to benefit from the recent era of economic growth and risi

In the 1970s, the policy and political elite obsessed about the 'British disease' -- the failure of our system of industrial relations, and its impact on UK prosperity relative to our competitors, above all the US. Forty years on, their concern should be whether we have caught the 'US disease': the failure of the broad mass of US households on low to middle incomes, the middle-class in American parlance, to benefit from the recent era of economic growth and rising productivity. Typical US family incomes today are at the same level as they were in the late 1980s, and median wages have flat-lined for an even longer period.

As the chart shows, the US has long had a problem with sharing -- that is, sharing out the proceeds of growth.

graph
Source: Machin, Centre for Economic Performance

The question is: are we catching their bug? Over the last decade the UK (as well as other countries like Germany) has started to show more US-like tendencies, as the relationship between economic growth and the pay rises going to the ordinary worker has weakened.

graph

Source: Resolution Foundation

There's no consensus as to what explains this great American stagnation. The easy bit is to point the finger at US policy mistakes that have certainly made matters much worse. Regressive tax policy, motivated by trickle-down theories; together with weak regulation motivated by a belief in the infallibility of markets, undermined their fiscal position, fuelled inequality and magnified economic instability. And the nature of the US political system itself poses a barrier to economic progress, with the efforts of President Obama -- like those of other Presidents -- being thwarted by deep and intractable political gridlock.

But to appreciate the deeper causes of the problem, we also need to consider the longer term hollowing out of the US jobs market. Leading US economist Jared Bernstein, who is in the UK this week to speak to a major conference on how the UK can avoid the US fate, puts it this way:

The developments that have hurt the US middle class -- and they are related -- are high levels of inequality and weak employment growth. Together, they have created a wedge between growth and broadly shared prosperity. UK policy makers take note: pushback on these forces or be prepared for a prolonged middle income squeeze.

The chart below demonstrates Bernstein's point. Each decade since World War II has seen fast employment growth (usually consisting of a dip during a downturn followed by strong growth as the economic cycle picks up). But prior to the recent recession, there was almost no employment growth: the jobs market was already flat-lining before it went into freefall.

graph 3

There are plenty of potential reasons for this decline -- the rise of an ever sharper focus on shareholder value, and more intense competition from China and India are both regularly blamed.

But the most likely villain is the changing relationship between technology and the jobs market. A leading view is that the rate of technological change has slowed down since the 1970s, and the new innovations which have occurred, particularly in ICT, are far less job-rich than was the case in previous waves of technological change (an argument advocated by US economist Tyler Cowen in his Great Stagnation). Another argument, set out in the latest zeitgeist e-book from the US, Race Against the Machine by Erik Brynjolfsson and Andrew McAfees, is that digital technology is changing faster than many workers can keep up with, rapidly encroaching into new sectors of the economy, leaving many workers economically displaced and disadvantaged (read this to see where these two perspectives converge and diverge).

If either of these are an accurate diagnosis, it's more than a bit worrying for the UK. We are of course exposed to precisely the same technological trends as the US; and prior to the recession we were already exhibiting many of the symptoms of a polarising labour market. Worse still, these long-term and underlying challenges are being made worse by short-term policy mistakes.

For now, our focus is rightly on injecting life into an economy with chronically weak domestic demand, whose main export market is in crisis. Beyond this, we need to contemplate how to avoid the US disease which, if caught, could mean that living standards for much of the country could be divorced from any future growth for a generation to come.