*However, America's reputation has been somewhat diminished by the thwarting of high-profile
foreign acquisitions—of Unocal, by a Chinese company, in 2005, and of a company that
managed U.S. ports, by Dubai Ports World, in 2006.
tGiven the upward bias of measured prices, a 1 percent reported rate of price increase probably
represents an economy with price stability.
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growth. Many economists in fact credit central bank monetary policy as the
key factor in the last decade's reduction in inflation worldwide. I would like
to believe that. I do not deny that we adjusted policy to be consonant with
global disinflationary trends as they emerged. But I very much doubt that
either policy actions or central bank anti-inflationary credibility played the
leading role in the fall of long-term interest rates in the past one to two decades.
That decline (and the conundrum) can be accounted for by forces
other than monetary policy. In fact, during my experience since the mid1990s
with the interaction between the policies of the world's central
banks and the financial markets, I was struck by how relatively easy it was
to bring inflation down. The inflationary pressures of which I was so acutely
aware in the late 1980s were largely absent or, more accurately dormant.
The "conundrum" exposed this point.
To judge success in containing inflation, central banks look to changes
in inflation expectations implicit in nominal long-term interest rates. Success
is evident when long-term rates slip in the face of aggressive monetary
tightening. But as I recall, during most of our initiatives to confront rising
inflation pressures, aggressive tightening was unnecessary. Even a slight "tap
on the brake" induced long-term rates to decline. It seemed too easy, a far
cry from the monetary-policy crises of the 1970s. The ten-year treasury
note yielded 8.7 percent on the day I was sworn in as Fed chairman and
rose to 10.2 percent by Black Monday. The yield on the ten-year note then
proceeded to fall for the next sixteen years, seemingly irrespective of the
Fed's policy stance. I often wondered how much we would need to raise
the federal funds rate to move the ten-year note higher for a sustained period.
Countering huge global financial flows would have been a formidable
task so long as international forces drove inflation expectations and real
long-term interest rates lower and pressed stock and real estate prices
higher. The forces driving the ten-year note appeared increasingly global.
The best policy under such circumstances is to go with the flow—to calibrate
monetary policy so that it is consistent with global forces. We did
that. During the global financial transformations that confronted the Fed
when I was chairman, our strategy was effective in that we understood
what policies were most consistent with the stability of American financial
markets. I doubt that we had the resources to counter the downward pres
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TH E "CON UNDRUM"
sures on real long-term interest rates, which were becoming increasingly
global. Certainly Japan did not.
The pervasive body of recent experience showing how effectively stable
prices contribute to economic growth and standards of living will be a
major incentive for world central bankers to contain inflationary pressures
in the future. As I put it at a congressional hearing a few years ago, monetary
policy should make even a fiat money economy behave "as though
anchored by gold." Is it possible that the world has permanently learned the
benefits of stable prices for economic growth and standards of living and
will maintain policies that sustain them? I will address this question in chapter
25.
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TWENTY-ONE
EDUCATION AND
INCOME INEQUALITY
D
D
espite an impressive five years of above-average economic growth
that drove the unemployment rate well below 5 percent, a majority
of Americans in 2006 reported significant dissatisfaction
with the state of the economy. There has been a sense in middle-income
America that in recent years prosperity's economic rewards have not been
distributed fairly. And indeed, though "fairness" is in the eye of the beholder,
it is true that income concentration has been rising since 1980.* The
mood of a significant proportion of those answering pollsters' questions is
disturbingly sour. The danger is that populist politicians, catering to such a
mood, can marshal unexpected majorities in the Congress for short-sighted,
counterproductive actions that could turn a state of bad feelings into a
truly serious economic crisis.
Overshadowing the current anxiety is a problem of longer standing:
many people's day-by-day experiences in the job market seem to contra
*The standard measure of concentration of household income, for example, the "Gini coefficient,"
rose steadily between 1980 and 2005 from .403 to .469. Polls give each respondent
equal weight, and there are far more lower- and middle-income earners who are doing poorly
than upper-income earners who are doing well.
EDUCATION AND INCOME INEQUALITY
diet the well-documented evidence that competitive markets over the decades
have elevated standards of living for the vast majority of Americans
and much of the rest of the world. Too many perceive the increasingly
competitive markets that are the hallmark of today's high-tech globalized
economy as continually destroying jobs, and those losses are all too visible.
Large layoffs are publicized in the media. Reductions in job slots in America's
factories and offices appear unending.
It is thus not surprising that competition is often seen as a threat to job
security. It is not perceived as a creator of higher wages either, although in
the end it always has been and inevitably will be now as well. In the decades
since World War II, real wages have risen as competitive markets have
moved the capital and workers employed in obsolescent, low-productivity
facilities to the new, more technology-intensive and thus more productive
means in turning out the nation's GDP. Consequently, as the economic pie
became larger, rewards to both capital and labor increased, and competitive
forces have tended to keep shares of national income accruing to employee
compensation and profits relatively trendless over the decades. The profit
share tends to rise and the employee share to decline in the initial stages of
a business cycle, and to reverse thereafter. And in fact if we look at the last
decade or two, we can see that the net result is that the distribution of
shares of national income between capital and labor has not been much
different from their distribution in the past half century. This means that
trends in real compensation per hour have tracked output per hour (that is,
productivity) closely since the end of World War II,* which in turn implies
that the distribution between labor compensation on the one hand and
profits of the gains from productivity improvements on the other has been
stable.
All this says little, however, about the distribution of labor compensation
itself, which includes the income of factory workers, other nonsupervisory
workers, and corporate executives, among others. It is not particularly
*If real labor income is a fixed share of real national income or GDP, then L = a . Y, where L =
real labor income and Y = real GDP, with a being labor's share of GDP. L = w . h where w is
the real wage and h is the number of hours worked. Since w . h = a . Yr then w = a . (Y/k), where
{Y/h) = real output per hour. Thus, if over the long run labor share is fixed, the real wage must
be proportional to output per hour.
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THE AGE OF TURBULENCE
comforting to a worker on the factory floor when his or her wage goes up
minimally while the company's CEO gets a multimillion-dollar bonus. The
distribution of labor compensation is driven by a different set of competitive
forces that govern the supply and demand for relative skills. For the
past decade, I have been tracking average hourly wages and salaries for the
four-fifths of our nonfarm workforce who are production or nonsupervisory
workers relative to the fifth who are "supervisory" employees, including
skilled professionals and managers. In the spring of 2007, the supervisory
workforce had average hourly salaries of approximately $59 per hour, compared
with $17 per hour for the nonsupervisory employees. That means
that one-fifth of the total number of employed Americans earned 46 percent
of total wages and salaries. In 1997, that percentage was 41 percent.*
The rise has been persistent over the decade. Average hourly earnings of
production workers went up 3.4 percent annually, while supervisory workers'
hourly earnings rose 5.6 percent.
Americans have generally been comfortable with high incomes from
efforts that demonstrably contribute to the economic well-being of the nation
and are thus clearly "earned." Although the notion of what is "earned"
and "not earned" is open to interpretation, people do not seem shy about
drawing conclusions. In recent years, for example, the American electorate
and their representatives in Washington have been decidedly less tolerant
of the dramatic rise in corporate executive compensation, an issue I will
address in chapter 23.
The complex set of market forces by which the nation's output is distributed
as income to the various creators of GDP is barely visible to the
average American. It does no good to argue that unrestrained competition
leaves a society on average better off, when, in recent years, workers see
their bosses gaining large bonuses as they themselves get tepid wage increases.
People have to experience competition's advantages firsthand. If
they do not, some will turn to populist leaders who promise, for example,
*The numbers are estimated matching Bureau of Labor Statistics data on payroll employment
(supervisory versus nonsupervisory), average hourly earnings of nonsupervisory workers, and
total wages and salaries including bonuses and exercise of stock option grants estimated by the
Department of Commerce from quarterly reports submitted to the Department of Labor by
almost all employers.
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EDUCATION AND INCOME INEQUALITY
to erect tariff walls. Such protectionism is perceived, erroneously, as securing
high-paying jobs in steel, autos, textiles, and chemicals—the icons of
America's past economic might. But twenty-first-century consumers are
less disposed to the products of those industries than were their parents;
the U.S. domestic economy, by implication, will no longer support the relative
wages and job levels contracted in those industries during negotiations
of an earlier period. Accordingly, steel and textile industry employment is
off sharply from the peaks of the 1950s and 1960s. The declines will likely
continue.
The loss of traditional manufacturing jobs in the United States is often
considered a worrisome hollowing out of the economy. It is not. On the
contrary, the shift of manufacturing jobs in steel, autos, and textiles, for example,
to their more modern equivalents in computers, telecommunications,
and information technology is a plus, not a minus, to the American
standard of living. Traditional manufacturing companies are no longer the
symbol of cutting-edge technologies; their roots lie deep in the nineteenth
century or earlier. The world's consumers have increasingly been drawn to
products embodying new ideas—cell phones over bicycles, for example.
Global trade gives us access to a full range of products without requiring us
to manufacture all of them domestically.
Were we to bow to the wishes of the economically uninformed and
erect barriers to foreign trade, the pace of competition would surely slow,
and tensions, I suppose, might at first appear to ease. After all, Richard Nixon's
wage and price controls were highly popular when they were imposed
in August 1971. The euphoria dissipated quickly as shortages began to appear.
It is likely that such a scenario of growing discontent would be repeated
were tariff walls raised. The American standard of living would soon
begin to stagnate, and even decline, as a consequence of rising prices, deteriorating
product choice, and, perhaps most visibly, our trading partners retaliating
by shutting out our job-creating exports.
Manufacturing jobs can no longer be highly paid, since it is consumers
who at the end of the day pay the wages of factory workers. And they have
balked. They prefer Wal-Mart prices. Those prices, reflecting Chinese low
wages, are inconsistent with a funding of high-wage traditional U.S. factories.
Forcing U.S. consumers to pay above-market prices to support factory
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salaries eventually would run into severe resistance. But by then, the American
standard of living would have fallen. The Peterson Institute of International
Economics estimates that the cumulative effect of globalization since
the end of World War II has added 10 percent to the level of the GDP of
the United States. Shutting our doors to trade would bring the American
standard of living down by that percentage. By comparison, the hugely
painful retrenchment in real GDP from the third quarter of 1981 to the
third quarter of 1982 was only 1.4 percent. Those who say it is better that
fewer people experience the stress of globalization even if it means that
some people are less wealthy are creating a false choice. Once walled off, a
country loses its competitive verve and begins to stagnate, and stagnation
leads to even more intense pain for more people.
If these dire outcomes are unacceptable, as I trust they are, what can be
done to counter the distorted perception of how jobs are gained and lost
and how incomes are generated? And how can we redress the reality of the
