A History of America's Disappearing
by Paul Krugman
www.alternet.org, March 9, 2007
Economist and New York Times columnist
Paul Krugman explains in simple terms how the American economy
went from having the world's most dynamic middle class to being
on the verge of a rich-poor state in only 30 years.
The following is excerpted from the keynote
speech delivered by Paul Krugman at the Economic Policy Institute's
recent conference on The Agenda for Shared Prosperity.
...One thing I've been noticing on multiple
debates in public policies -- climate change is another one --
is there seems to be an almost seamless transition from denial
to fatalism. That for 15 or 20 years the people would say, "No,
what you're saying is not happening." And then almost immediately
they'll turn around and say, "Well, yeah, sure it's happening,
but there's nothing that can be done about it."
And that's kind of the way a lot of the
discussion now goes on inequality. That there is really nothing
you can do to arrest this. That it's all the invisible hand driving
this growth in inequality, and there's nothing you can do to really
change it -- well, maybe better education. But while education
is very much a good thing, it's the all-American way of dodging
problems. Since everybody approves of it, you say we should have
better education but wave away the pretty strong evidence that
while it's a good thing, it won't make very much difference. So
there's this general sense that you can't do anything.
And I don't think that that's what the
historical record suggests. That in fact when we look at it, there
appears to be quite a lot that the political process can do about
inequality. Just to say, there's the obvious. Obviously, even
if you look at the United States right now, the tax and social
insurance system makes an enormous difference.
But the amount of inequality in the United
States is substantially less than it would be if we did not have
still at least somewhat progressive taxation, and still a pretty
extensive, though not nearly extensive enough, system of social
insurance. And that makes a big difference. Certainly if you're
looking at say the United States versus Canada, a lot of the difference
between the two countries is just that Canada has more of a better
safety net financed by somewhat higher taxation.
And if you're looking for a progressive
agenda, certainly from my point of view, a large part of that
ought to be straightforward orthodox stuff, which is still very
hard to do politically. It would be essentially restoring progressivity
of the tax system, and using the revenue to improve social insurance
and, above all, health care.
So, if you say what would I really like
if I went into a Rip Van Winkle sleep and woke up ten years from
now, I'd like to wake up and discover that we have a national
health care in some version with the necessary funding supplied
in part by higher taxes on me, or actually, the top two percent
of the income distribution. But people a lot richer than me, of
course. But it's not the whole story that the only thing you can
do is taxes and social insurance. And the arc of history for the
United States suggests that there's actually a lot more that can
If you look back across the past 80 years
or so of the United States, what you see is that in the 1920s,
we were for practical purposes still in the gilded age. That may
not be the way the historians cut it, but in terms of the actual
distribution of income, so far as we can measure it in terms of
the role of status and general feel of the society, we were still
an extremely unequal royalist society.
By the time World War II was over, we
had become the middle-class society that the baby boomers in this
audience grew up in. We had become a much more equal society.
That high degree of equality began to go away -- depending on
exactly which numbers you look at -- during the late 70's, maybe
a little earlier than that. And at this point we're basically
back to pre-tax and transfer to the levels of inequality that
we had in 1929.
So there is this great arc to the middle
class, away from gilded age to middle-class society and then back
to the new gilded age, which is now what we're living in. And
there are really two puzzles about that. One of them is a political
puzzle, which is why instead of leaning against these trends,
politics has actually reinforced them. Why it is that U.S. politics
moved left in the age of a relatively middle-class society, and
moved right as society got more unequal?
A naïve view of politics would say
that, "Gee, when a few people are winning a lot and most
people are lagging behind, people ought to be voting for more
social insurance and more progressive taxation, not less."
And we have some understanding of why that doesn't happen. It
has to do with the role of money, organization and all of these
other things that affect politics. That story also helps us understand
why politics gets so nasty.
If you actually look at some of the measures
-- I'm really into quantitative political science these days --
of political positions that political scientists calculate, it
does look as if what the main thing that moves actually over time
is in fact the Republican party. The Democratic Party has not
-- at least with northern Democrats -- gotten significantly more
liberal over the past. They haven't moved much at all over the
past 30 years.
But the Republican Party, which had largely
converged on the Democrats in the age of Eisenhower, has moved
sharply to the right. And so that one party, in effect, moves
with the income of the top 5 percent or 1 percent of the population.
So that seems to be the story. I mean, we can think about reasons
why that might be true. But the other puzzle, and this comes to
the question of the conference, is what drove these changes? How
did we become largely middle class?
Why have we become a much more unequal
society once again? And the standard, what economists like to
say, is "Well, it's all invisible hand. It's all market forces."
The history doesn't seem to look like that, if we ask how did
the society we had in 1947, which is when a lot of our data start,
come into existence.
Was it a gradual process whereas the economy
developed and we got out of the early days of the American industrial
revolution, we gradually moved towards middle classness? Well,
no, historically it happened in an eye blink. In this Claudia
Golden and Bob Margot classic paper, they call it the great compression.
As late as the late 30s, the income distribution appears to be
By the time you wake up in 1946 or so,
it's highly equal. And how did that happen? A lot of it was more
or less deliberate compression of wage differentials during World
War II. But if you were or had standards, supply and demand for
different types of labor, you'd say that should last only as long
as the wage controls lasted. It should have sprung back to where
it was, but it didn't. It actually stayed quite equal for another
30 years at least. You ask, what buttressed that? Well, partly
it's the rise of a powerful union movement, which is at least
in large part a change in the political climate, but then remained
in place for several decades more.
Other things we're not sure. But it looks
more or less as a leveling of the income distribution. Obviously
we want to be careful about the words. No one presumably in this
room, and certainly not me, is advocating Cuba. We're not calling
for a flat income distribution. But the relative equalization
that seems to have taken place was engineered by a combination
of top-down politics and grassroots organization that made people
want a more equal society in the 30s and the 40s, and they got
And it remained for quite a long time.
Now, that started to come apart roughly 30 years ago, and there's
been a large increase in inequality since then. As people probably
know, I've written about the part that is sort of polite to talk
about, which is the rising premium for highly educated workers.
But that's only part of it. Even more spectacular is the increase
in inequality of the far-right tail of the income distribution.
The CEOs and high school teachers who
got roughly the same number of years of formal education haven't
exactly had the same growth in income over the past 30 years.
So, there's this vast increase in inequality at the top. What
do we think caused that? I actually just had to do a class on
that. It was in my international trade class, but we were doing
the trade and inequality stuff.
And the question is what do we think is
underlying the rise in inequality in the United States? And searching
for metaphor, I actually ended up with the "Murder on the
Orient Express." Not for what actually happened but for the
way we described it. In "Murder on the Orient Express,"
somebody is killed and there are 12 suspects. The question is
which of them did it and the answer actually is all of them. The
official economic story about rising inequality is one in which
we have a whole bunch of villains, which all seem to be playing
So we've got skill bias and technological
change, which is shifting demand towards highly educated workers.
We've got growing international trade with increased imports of
labor-intensive products further reducing demand for less educated
workers. We have immigration, possibly similar in its effect to
trade. We have the falling real value of the minimum wage contributing
at the bottom end. We have some affected unionization driving
the change in income distribution.
Finally, in terms of at least the after-tax
distribution, we have changes in taxes which have, in general,
reinforced rising inequality. It could be true, but it's kind
of funny that all of these different things should be working
in the same direction. In "Murder on the Orient Express,"
there is an elaborate conspiracy that means that all 12 of the
potential suspects were actually in collusion. It's a little hard
to see how all of these factors and economics are in collusion.
Okay, I think that what we can say is
that the political climate matters more for the distribution of
income than the economic models that we know how to work with
and would seem to suggest more than our models capture. If you
ask me practically what I want done now, I think that the most
important agenda thing right now is, in fact, to work on the taxes
and social insurance side, because that is concrete and you can
But there is a lot of reason to believe
that a change in the political climate in various ways can do
a lot more than you would think just from looking at the taxes
and social insurance. Let me give you two pieces of evidence that
I looked at. One is that there is some really interesting, though
intellectually disturbing, work by my colleague, Larry Bartell
who is in the Princeton Politics Department and has just looked
at what happens to income growth at different points in the income
distribution under administrations of the two parties.
Now there shouldn't be a big difference
really because at any given historical period, the visible policies
are not all that different. Certainly there is a pretty significant
shift from Clinton to Bush and there was, in fact, a pretty significant
shift from Bush to Clinton previously. But it's in taxes and it
really shouldn't be very obvious at pre-tax distribution of income.
And yet what Bartell finds is actually there is a really striking
difference. Inequality on average rises under Republicans. At
least in the bottom 80 percent of the income distribution, it's
stable or falling under Democrats. The top 1 percent just kept
on rising right through, but there is at least a surprising, fairly
The other thing I would say is timing.
There's a very clear co-movement over time between income inequality
and both the political polarization and the rightward tilt of
our politics. It's pretty clear that the rising inequality over
the past 30 years has been associated with a rightward shift of
the political center of gravity, mainly because of the Republican
Party shifting to the right.
You might say that's the causation running
from income distribution to politics. But if you actually then
just start to look at it through history, the timing actually
seems to be reversed. The rise of an aggressive or rightwing movement
and the rise of a really major assault on the New Deal great society
legacy both come before the big shift in income distribution takes
The emergence of the modern right is something
that obviously dates back to Goldwater, but really becomes a political
force in the '70s. You don't really see the big changes in income
distribution until the '80s. So it looks almost as if, just in
this crude sense, politics is leading the economic changes. How
could that operate? I just want to talk about two things. I suspect
that there are quite a few channels that we don't really perceive,
but there are two that are fairly clear. One of them is unionization.
Obviously, private sector unions were
very important in the U.S. 30 years ago and have very nearly --
not completely, but very nearly -- collapsed, and they are down
to eight percent of private employment. Why did that happen? You
will often see people saying -- well, that's because of de-industrialization,
and because of the decline of manufacturing. But that is actually
not right. It's not right in two ways.
First of all, arithmetically, most of
the decline in unionization is a result not of the decline in
manufacturing share, but of the decline of the unionization of
manufacturing itself. So the big thing that happens is that there
is a collapse of unionization within the manufacturing sector
and then of course also a smaller share of manufacturing in the
economy, but it's much more dramatic on the collapse within the
The other is that there is no law that
says that unionization should be a manufacturing phenomenon. What
it really is, to the extent that there is a story, is that large
enterprises are more likely to be to be unionized. The reason
why the high tend of unionization was also a period when manufacturing
was the core of the union movement, is that at that time, large
enterprises were largely a manufacturing phenomenon.
Now we have a service economy in which
there are a lot of large service sector enterprises. Not to put
too fine a point on it, but why exactly couldn't Wal-Mart be unionized?
It doesn't face international competition. There is no obvious
reason why it wouldn't be possible to have a strong union in Wal-Mart
and in the big box sector and other parts of the economy. And
just think of how different the whole political economy would
look if the service sector enterprises were unionized.
Not necessarily all the effects would
be positive, but it would certainly be very, very different. What
happened? Why did manufacturing unionization collapse? Why didn't
the emerging service sector get unionized? And the answer is actually
pretty straightforward and pretty brutal. It's politics and aggressive
employer behavior enabled by politics.
I have seen estimates of a fraction of
workers who voted for a union and who were fired in the early
'80s. They range from a low of one in 20 to a high of one in eight.
There is no question that aggressive, often illegal, union busting
is the reason the union movement declined. And the change in the
political climate that began in the '70s clearly played a role
in making that possible.
Now how important is all of that? You
may have seen that there have been a number of estimates of the
effects of unions on income distribution. It's funny. People will
often say that those estimates are small and actually they typically
are roughly comparable in size to typical estimates to the effect
of international trade on income distribution. So these are both
in secondary and the standard accounting to technological change,
but both fairly significant.
What is more, there are a lot of reasons
to think that those estimates are not capturing a lot of the story.
As the people who do them will concede, what they basically do
is say: What if the workers were paid, unionized and non-unionized
workers were paid the same as they are now, and just do a sort
of shift share analysis. What that doesn't capture -- and they
know it, but there is just no way to do it better -- is the effect
of a strong union movement on the bargaining position of workers
who are not unionized, but might be.
It doesn't capture the effect of a strong
union movement and possibly disciplining insider behavior by executives
and so on down the line. So it is likely that that is a much more
important story than we typically give it credit for being. Let
me just give you my other piece of the story, executive compensation.
There's a raging debate now of how much of the soaring executive
compensation is insider self-dealing, and how much of it is just
I went back and was looking at what people
said about executive compensation when it was low, just 40 or
50 times the average worker salary. [Here are] some quotes: "Managerial
labor contracts are not, in fact, a private matter between employers
and employees." "Parties such as employees' labor unions,
consumer groups, Congress and the media create forces in the political
media that constrain the types of contracts." And so on down
A lot of discussion was of the role of
the political climate that was basically hostile to outrageous
paychecks and constrained it. Where are these quotes from? They
are actually from [economists] Michael Jensen and Kevin Murphy
writing, saying people have complained that there are not enough
incentives in executive pay. They are saying that what we really
need is to have executives get more stock options and stake in
the firm -- in other words, all of the stuff that has happened
So back when executive pay was low, 40
or 50 times average pay, it was actually the defenders of higher
executive pay that complained that it was actually non-market
forces that were constraining executive pay. Now of course that
disclosing of pay has happened, the same side of the debate says
it's ridiculous to claim that social norms and political forces
have any role in this. But I think it's actually quite clear that
it did. We can argue about which is the natural market outcome.
But the point is, in fact, that we had a society 25 years ago
in which there were some constraints imposed by public opinion,
by strong unions, by a general sense that there were things that
you don't do.
And maybe that led firms to make a decision
to think of there being a sort of tradeoff between a "let's
have a happy high morale" workforce, or let's have a super
star CEO and squeeze the workers for all we can. There were some
things that tilted the balance in that decision.
Okay, are we going to do another great
compression? Hopefully not. The reason I say hopefully not is
even FDR needed World War II to be able to carry out that sort
of wholesale social engineering that took place. I am not looking
forward to having a replay of that. I think that if we get serious,
as some of us hope we do, and we actually do have a swing back
in the political pendulum that -- in addition to the direct stuff
-- we can do a lot to change the climate in the many small ways
that add up to a lot of impact on the bargaining power of workers.
The ability of the bottom 80 percent of
the population to get a bigger share of the total pie -- I think
that if we get there, we may be surprised at just how successful
we are at moving ourselves back, at least part of the way, to
the kind of middle-class society that people like me grew up in.