Plenty of Nothing: The Downsizing of the American Dream and the Case for Structural Keynesianism

By Thomas I. Palley

Business papers today are in a triumphant mood, buoyed by a conviction that the economic stagnation of the last quarter century has vanished in favor of a new age of robust growth. But if we are doing so well, many ask, why does it feel like we are working harder for less? Why, despite economic growth, does inequality between rich and poor keep rising? In this wide-ranging and provocative book, Thomas Palley pulls together many threads of "new liberal" economic thought to offer detailed answers to these pressing questions. And he proposes a new economic model--structural Keynesianism--that he argues would return America to sustainable, fairly shared prosperity. The key, he writes, is to abandon the myth of a natural competitive economy, which has justified unleashing capital and attacking unions. This has resulted in an economy dominated by business.


Palley's book, which began as a cover article for The Atlantic Monthly in 1996, challenges the economic orthodoxies of the political right and center, popularized by such economists as Milton Friedman and Paul Krugman. He marshals a powerful array of economic facts and arguments to show that the interests of working families have gradually been sacrificed to those of corporations. Expanding on traditional Keynesian economics, he argues that, although capitalism is the most productive system ever devised, it also tends to generate deep economic inequalities and encourage the pursuit of profit at the expense of all else. He challenges fatalists who say we can do nothing about this--that economic insecurity and stagnant wages are the inevitable results of irresistible globalization. Palley argues that capitalism comes in a range of forms and that government can and should shape it from a "mean street" system into a "main street" system through monetary, fiscal, trade, and regulatory policies that promote widespread prosperity.



Plenty of Nothing offers a compelling alternative to conventional economic wisdom. The book is clearly and powerfully written and will provoke debate among economists and the general public about the most stubborn problems in the American economy.

• Language: English
• Publisher: Princeton University Press
• Release date: Mar 9, 2021
• ISBN: 9780691227603

Book preview

CHAPTER 1

Debunking Economic Naturalism

THIS BOOK is about the American economy and the gradual dismantling of mass prosperity that has been taking place over the last twenty-five years. The focus of the book is on long-term trends that continue to operate on the economy independently of the temporary ups and downs of the business cycle. Though the economy periodically experiences cyclical booms, underlying the booms of the last twenty-five years has been a persistent downward trend.

This interaction of trend and cycle makes understanding the economy a difficult task. When the economy is up, it is easy to forget about the recent down. Moreover, this proclivity to short-term memory is compounded by the fact that people are optimistic, and all too ready to believe that each economic recovery marks a new beginning. That optimistic psychological disposition then inclines them to believe that their earlier concerns were misplaced, and that there is no longer any need for altering their economic course. In this fashion, Americans have ridden the economic roller coaster that has seen the majority slip behind while the few have prospered.

This proclivity to believe that each new business cycle marks a fresh start is dramatically reflected in our current experience. In April 1997, the U.S. unemployment rate fell to a twenty-three-year low of 4.9%. Following the release of this report, newspapers were filled with stories about how the U.S. economy had successfully reinvented itself.¹ Yet, just fourteen months earlier, Americans had been wrestling with the trauma of rising economic insecurity and the disappearance of the middle class: The New York Times even ran a week-long special (March 1996) titled The Downsizing of America. Moreover, even as the unemployment rate was hitting 4.9%, average hourly wages actually fell fractionally. As documented in chapter 4, the purchasing power of average hourly wages has actually fallen during the most recent business cycle and remains far below the peak level of wages reached in 1973.² If this is economic reinvention, something is lacking.

Capitalist economies have always had booms, and they will continue to do so. The current economic boom is therefore not at odds with the claim of an on-going erosion of the American Dream. Indeed, the character of this boom provides some confirmation. In past booms, there would have been significant wage gains at this stage of the business cycle. In the current boom, there has been welcome relief on the employment front, but wage stagnation persists; hence the claim plenty of nothing.

The fundamental thesis of this book is that restoring widely shared and growing prosperity will require major changes in the direction of economic policy. Effecting such change will require that people reassess their thinking about the economy, for economic policy is ultimately the reflection (albeit indirect) of popular thinking as expressed through the collective choice process that is politics. In the absence of these changes, the economy may continue to grow, but economic polarization between rich and poor will also continue to expand.

Sixty years ago, the great British economist John Maynard Keynes struggled to change popular understandings of the causes of the Great Depression. The orthodoxy of the day promoted an economic fatalism that opposed attempts to stimulate spending despite the overwhelming presence of unemployment: the orthodox claim was that any government attempt to increase spending would merely displace an equal amount of private spending. For Keynes, the difficulty in persuading people lay not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.³ A similar argument can be made today regarding an array of issues ranging from the claim that a dose of economic austerity is the prerequisite for restoring economic prosperity, to the claim of a binding inflation constraint that compels us to live with permanently high interest rates and unemployment.

Despite temporary relief, most Americans are apprehensive about the economy, and they have reason to be. For the last twenty years, the wages of the average worker have been falling, economic insecurity has been growing, and the prospects for future prosperity have been receding. This is not a matter of progress at a slower pace: rather, we are going backward. The existing configuration of economic arrangements and policies has produced this outcome, and the belief that the market will suddenly reverse its existing course in an act of goodwill is tantamount to the fatalist thinking that characterized the depression era.

The restoration of the shared and growing prosperity that marked the immediate post-World War II era requires the restoration of an appropriate balance of power within our economic system. The technological and organizational changes of the last thirty years have upset the previously extant balance of power among government, big business, and labor. As a result, there is a need to recalibrate our system so that it again delivers for all.

STRUCTURAL KEYNESIANISM

The notion that we need to recalibrate our economic system gives rise to an economic philosophy that I call structural Keynesianism. Like traditional Keynesianism, it shares the fundamental proposition that capitalism is the most powerfully productive social system that has ever been created. Capitalist economies are capable of generating a greater bounty of goods and a higher standard of living than any economic system heretofore, or any economic system we can currently imagine.

Like traditional Keynesianism, structural Keynesianism also shares the core proposition that capitalist economies have a fundamental tendency to generate a deficiency of demand for the goods and services that they are capable of producing. Moreover, this deficiency of demand can occasionally be severe enough to generate economic depressions and mass unemployment. A large class of problems in capitalist economies can therefore be understood by reference to the principle of aggregate demand—that is, by understanding the economic forces determining the total demand for goods and services in an economy. Keynes and his followers understood this principle, and in the period after World War II they applied it in guiding economic policy. The result was an unequaled period of full employment during which the scourge of mass unemployment was replaced by mass prosperity.

This period of success led Keynesian economists to believe that demand management, conducted by government through its control over interest rates (monetary policy) and government spending and taxes (fiscal policy), was sufficient to eliminate permanently the problems of the business cycle and unemployment. Behind this belief lay an implicitly static view of the world, in which the structure of the economy was fixed so that monetary and fiscal policy would always be feasible, effective, and sufficient means of managing demand and ensuring prosperity.

The last twenty years have been marked by the return of higher rates of unemployment and the withering of popular prosperity. This has undermined the sanguine prognosis of traditional Keynesianism. Thus, it has become increasingly difficult to apply expansionary monetary and fiscal policy, and, even when applied, the results have not been as in the earlier period. It is true that expansionary monetary and fiscal policy are still able to reduce unemployment, but the reduction has proven temporary. Moreover, Keynesian demand management policy has been impotent with regard to the problems of widening income inequality and stagnating wages. It has also become increasingly difficult to pursue expansionary policies owing to mounting government debts and the threat of a sell-off in bond markets, which raises interest rates.

Structural Keynesianism builds on the analytic inheritance of traditional Keynesianism. Thus, it recognizes both the unequaled productivity of capitalist economies and the tendency of capitalist economies to generate problems of insufficient demand. However, it supplements the Keynesian argument in two important ways. First, just as there is a proclivity to generate insufficient demand, uncontrolled capitalist economies also have an unyielding tendency to generate exploitation of ordinary people that results in a distribution of income in which a few have vast riches and the many have some or none. This skewing of income distribution in turn feeds back adversely on the level of demand. As a result, income distribution takes on a profound import, because running a system of mass production at full employment requires a robust mass market, which requires a healthy distribution of income to support demand. From a policy standpoint, income distribution is of concern not just for ethical reasons of equity, but also for reasons of economic prosperity.

Second, structural Keynesianism recognizes that capitalism is a dynamic system in which business seeks to promote an economic environment that maximizes profits. This means that business will seek to influence policy by such activities as political lobbying. Even more importantly, business will also innovate with regard to production technologies and methods of business organization, and these innovations will change the economy’s structure. Though the abstract driving forces of capitalist economies remain unchanged, the specific visible economic arrangements and production techniques are constantly changing. This economic dynamic is summarized as follows: the more things change, the more they remain the same, while at the same time one can never step in the same river twice.⁴

This recognition of the dynamic process governing economic activity has momentous implications for the conduct of economic policy. Traditional Keynesians believed that demand management was sufficient to ensure full employment and popular prosperity, and their early success convinced them of this belief. However, the reality is that the period immediately after World War II was characterized by a configuration of structural factors that was highly conducive to successful demand management. This structure included strong trade unions, controls on international movements of financial capital, limited ability of business to relocate jobs, and strong domestic demand conditions.

Over time, these favorable conditions have gradually been eroded, and replaced by unfavorable conditions that render demand management policies less effective and less feasible. This change did not happen by accident or bad luck: rather, it reflects the systematic workings of the free market. Thus, through a combination of technological innovation, organizational innovation, and political action, business has succeeded in asserting dominance over both government and labor. As a result capitalism’s proclivity to unequal income distribution and demand deficiency is reasserting itself with a refound vengeance.

Such an analysis gives rise to three fundamental propositions of structural Keynesianism.

Proposition I. Keynesian demand management can only solve the systemic problem of deficient demand if an appropriate economic structure is in place.

Proposition II. Keynesian policies of demand management must be supplemented by regulatory policies that ensure an appropriate economic structure. This requires regulation of business (both industrial and financial), regulation of international financial markets, and regulation of labor markets. These regulatory structures must be designed so as to preserve the incentives for productive enterprise that are the source of capitalism’s bounty.

Proposition III. These regulatory policies need to be periodically updated because capitalism is a dynamic process that will persistently seek to evade them. If regulation is successful, it means that it is binding in the sense of restraining business from doing something it would have freely chosen to do in the absence of regulation. This sets up an incentive to innovate (technologically or organizationally) so as to circumvent the regulations.⁵ Over time, this process of innovation will be successful, which means that regulations have to be periodically updated. In effect, successful regulation always sows the seeds of its own destruction.

POLITICS BEFORE ECONOMICS

Structural Keynesianism elevates the significance of structure and policy, and in doing so it forces politics to the forefront of the stage. Structure is inevitably a political matter: the establishment of a structure conducive to widespread prosperity can only be accomplished by individuals acting in concert; achieving prosperity within that structure then becomes the province of individuals acting on their own account.

This is the great paradox of free-market capitalism. Though driven by the pursuit of individual self-interest, all free-market economies require some collectively agreed upon structure. The popular myth is that free markets are free of structure, but this is a fabrication. Even the most radically laissez-faire economy rests on laws and institutions governing and enforcing the rights of property and the obligations of contract: at a minimum, there is always a policeman, a judge, and a jailer. It is also true that such a minimalist structure will never generate the widespread prosperity that is the hallmark of the American dream.

The failure to recognize that widespread prosperity rests on appropriately designed market rules and regulations is the cancer that is killing the American dream. Thus, as the old regulatory structure that promoted the success of Keynesianism has withered, we have failed to update it. Instead, by a combination of default, misunderstanding, and apathy, Americans have gotten locked into a new set of market structures that set worker against worker to the disadvantage of all but big business. This new structural environment generates a cruel paradox: the pursuit of self-interest, which is both individually rational and the source of the bounty of free markets, ends up hurting ordinary workers. Worse still, none can escape: not to pursue one’s self-interest while others do, is to consign oneself to an even worse economic predicament. This is the logic of the infamous prisoner’s dilemma, and it is easily illustrated.

The Stock Ownership Dilemma. Many Americans own small amounts of stock. Each individual wants higher profits at the company in which he owns stock, as this will increase the stock price. If these profits come from reduced company wages, that’s all right because the individual does not work there. However, when all adopt this mentality, everyone is worse off. The increased stock value pales by comparison with the decreased value of wages, which represent the dominant source of income for working Americans. The sole beneficiary is the small group of the wealthiest Americans who own most of the stock. Despite this, each of us has a private interest to canvas companies in which we hold stock to seek higher profits through wage reductions—as long as it’s not at our own place of employment.

The Rat Race Dilemma. Most people want to make it to the top, and win the prize of a high salary that goes with being at the top. To get there, they try and distinguish themselves by working harder, which involves putting themselves under increased strain and stress, reducing their community involvement, and shortchanging their families of time and attention. However, when their colleagues see them working harder, they too have an incentive to respond by increasing their effort because they also want to get to the top. Consequently, a rat race develops in which each tries to outwork the other. From the start, only one can be top dog: yet, all have an incentive to participate in a rat race that makes all but one worse off.

The Wal-Mart Dilemma. During the 1980s, the Wal-Mart chain of discount stores spread across rural America. In its wake, it decimated downtown business districts as local retailers and merchants could not compete with Wal-Mart’s buying power, which enabled it to offer lower prices. Local residents, including the local merchants who were being driven out of business, had an incentive to shop at Wal-Mart to get these lower prices. Yet at the end of the day, communities were worse off, with downtowns destroyed and higher paid dignified local business employment replaced by low-paying service work at Wal-Mart.

The Automobile Dilemma. Most people want cars that are safe and have good gas mileage. To get a little more safety, people may buy a slightly bigger car, and sacrifice a bit of mileage. However, when one person buys a bigger car, it makes persons driving smaller cars less safe as they are more likely to be hurt in collisions. Drivers of small cars then have an incentive to buy slightly larger cars, so that none are safer. In this fashion, people may end up driving large low-mileage cars that leave everyone worse off.

These are a few examples of how prisoner-dilemma-type problems permeate markets. Each person rationally pursues his self-interest, which is exactly what free markets are supposed to thrive on. Yet, at the end of the day, this can make everyone worse off. However, not to pursue self-interest while others do, makes individuals even worse off: consequently, there is no opting out.

Not only do these problems apply to individuals, but they also apply to governments as can be seen from the following examples.

The Tax Auction Dilemma. Recently, many state governments have been giving generous business tax exemptions either to attract new business or to get existing business to stay. However, when the state next door (consider New York and New Jersey) sees that its neighbor is giving such exemptions, it too has an incentive to give exemptions. As a result, an auction of tax exemptions develops. By such means, New York may ultimately be able to persuade business to stay, but the resulting lower tax revenues must be made up by additional property taxes on households.

The High Interest Rate Dilemma. Financial capital is highly mobile in today’s globalized financial markets. International money now flows between London, New York, and Tokyo in search of the highest interest rate, and these flows can trigger an exchange-rate crisis if they happen in large sudden fashion. To guard against this possibility, countries try to keep their interest rates fractionally above the global average. However, if one country follows this strategy, then others are obliged either to follow or face an exchange-rate crisis. Yet, when every country adopts this strategy, the result is to push up the global average interest rate, resulting in higher interest rates everywhere.

The implications are clear. The prisoner’s dilemma is a problem that pervasively afflicts both individuals and governments, and it derives from the structural arrangements governing markets. During the course of this book, we shall see it reappearing over and over again. Resolving the problems it poses, requires establishing market governance structures that prevent destructive pursuit of self-interest that ends up harming all. Establishing such governance structures is a matter of collective choice rather than individual action, and it is in this sense that politics comes before economics.

STRUCTURAL KEYNESIANISM VERSUS ECONOMIC NATURALISM

Structural Keynesianism recognizes the need for institutional design that promotes economic well-being. This recognition of the significance of design contrasts with the dominant economic philosophy of the day, which I term economic naturalism. The latter rests on an appeal to nature and views the economy as a product of nature: hence, the appeal to the notion of a natural rate of unemployment, a natural rate of interest, and a natural rate of growth. This appeal brings with it rhetorical advantage because, by implication, everything else is unnatural. More than that, it brings with it an economic mentality that can be termed economic fatalism. If the economy is fixed by nature, then there is little we can do about it. Instead, we just have to lump it and live with it. Of course, this appeal to nature is not politically neutral: it ends up favoring the status quo.

The triumph of economic naturalism over the American mind is the ultimate source of our current fatalistic attitudes, which maintain that the economy is beyond our influence. Hence, globalization and the dominance of business are viewed as inevitable outcomes, and we should be grateful that there are jobs and that wages do not fall.

Structural Keynesianism stands in stark contrast to economic naturalism. Whereas the latter sees the economy as predetermined and given, the former sees it as the outcome of choices. Whereas the latter promotes policy fatalism, the former promotes policy activism that seeks to create prosperity by design. There are constraints on prosperity: these are people’s attitudes to enterprise, the wealth of a country as measured by its natural resources and factories, and the level of knowledge and technological advance. However, that said, the extent to which these endowments produce prosperity, and the manner in which that prosperity is shared, depend on the design of our economic institutions and laws and the economic policies we adopt.

ECONOMICS AND THE END OF THE COLD WAR

Economic naturalism dominates the American mind. Its dominance was reinforced by the Cold War, which continues to exert an influence despite its finish. A widely held belief is that the end of the Cold War signaled the triumph of free-market capitalism, and that henceforth only one type of economic system would be viable.⁶ Moreover, that economic system is the one we already have, so that the economic question is settled de facto and there really is no choice.

For those at the top of the income distribution, this is a comforting story. However, this claim rests on a false dichotomy that contrasts a utopian laissez-faire capitalism with extreme Soviet-style authoritarianism. The reality is that capitalism has always come in a range of forms, and today we are edging toward a return to the extreme form that characterized conditions before the New Deal. The triumph of this no choice mentality has therefore become another obstruction obscuring the real problem of establishing the capitalism that works best.

Scanning the world’s economies is revealing of the range of capitalisms, and the same is true for the history of the American economy. Thus, the capitalism of the period 1950-1970 represents a different capitalism from that of today. Whereas the former worked for Main Street America by sharing the fruits of economic growth, current arrangements pit citizen against citizen in a vicious struggle that redounds to the benefit of the few who own and manage America. Viewed in this light, the message from the end of the Cold War is not the end of choice, but rather that America must choose whether it wants yesterday’s Main Street capitalism or today’s Mean Street capitalism.

During the Cold War, both sides engaged in vigorous ideological propagandizing on behalf of their respective economic systems; the Soviets peddled utopian communism, whereas America peddled utopian capitalism. The collapse of the Soviet Union left the propaganda of utopian communism completely discredited, but America’s triumph left the propaganda of utopian capitalism intact. As a result, America remains burdened by its Cold War ideological baggage.

The ideological character of the Cold War meant that discussion of the fundamental nature of the economy was out of bounds, and instead America claimed to have permanently solved the economic problem. This claim was reinforced by historical circumstance after World War II, whereby military spending, the rebuilding of Europe and Japan, the reforms associated with the New Deal and the G.I. Bill, and the accumulation of five years of pent-up World War II consumer demand, all combined to push the U.S. economy onto a trajectory that provided twenty years of growth and spreading prosperity. The result of this confluence of events was that Americans came to believe their own ideological rhetoric, claiming to have permanently solved the economic problem. In the process, the very language needed for talking about the economy was forgotten. The end of the Cold War therefore poses a challenge that requires Americans relearn how to talk about the economy. Rather than signalling the triumph of a fictitious utopian capitalism, the choice is between Main Street capitalism and Mean Street capitalism.

LESSONS FOR EUROPE

Though this book is principally about the American economy in that it uses American economic data to make its arguments, both the central thesis and many of the specific arguments also apply to the economies of Western Europe. The transition to Mean Street capitalism is more advanced in America, but there are powerful forces seeking to accelerate the transition in Europe. The arguments are therefore directly relevant to European debates over free trade, the role of unions, and the role of government in ensuring full employment and a fair distribution of income. Taken in isolation, each of these policy debates can appear as specific and contained in nature. Considered collectively, their resolution will determine whether European Main Street capitalism is replaced by its Mean Street cousin.

Fortunately, there are a number of reasons to be optimistic about the outcome. These include the existence of the European Community, the foundations for which were established in the 1950s. The Community’s institutions embody the optimistic outlook that characterized that period of European renewal, and this outlook is built into its legal charter and organizational culture. A second reason for optimism is the structure of European politics. In Europe, there exist well-defined mainstream labor parties, and trade unions view themselves through a historical lens that commits them to broad concerns with national economic and social policy. This widens the scope of public debate and contrasts with America, which lacks a labor party. However, Europe has its own political problems. Whereas cultural politics is America’s great distraction, in Europe there is the persistent danger of reactionary nationalist politics, which can be used to hijack the economic debate.

CHAPTER 2

Making Sense of the Economy and Economics

AS ECONOMIC advance has waned for larger and larger numbers of people, an understanding of the roots of prosperity has become ever more vital. In this climate of economic stagnation and insecurity, politicians and economists have pushed competing and conflicting policies. Naturally, all claim to be acting in the best interests of ordinary Americans. However, ordinary Americans seem ever less certain of how the economy actually works, what is the cause of the vanishing American dream, and whose policies will really improve their economic condition.

This confusion is manifested in two ways. First, there is an increasing skepticism with the rosy prognostications of professional economists, whose analysis is so deeply