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Judith Stein: Crisis is the fruit of policies that encourage low wages

[Judith Stein is a history professor at City College of New York.]

The volatile stock market and credit freeze focus the mind on crisis management. But this calamity is connected to 30 years of policies that encourage low wages.

After World War II, it was believed that high wages were good for the economy as well as workers. But a new economic model came into favor after 1980.

Its signatures were low taxation, deregulation and free trade. Its logic was that capital freed from government and unions would produce prosperity for all. It benefited such industries as defense, financial services and real estate, while it hobbled manufacturing.

The new economic agenda really took off in the 1990s, when the collapse of the Soviet Union and the opening up of China and India doubled the global labor force. The financial-services industry bankrolled factories that employed these workers, further weakening organized labor, and cheap imports flooded the rest of the world.

Corporate profits soared as productivity increased and wages stagnated (except for the period from 1995 to 2000). The financial-services industry now accounts for a little more than 20 percent of U.S. gross domestic product, compared with about 12 percent for manufacturing. The financial industry's share of corporate profits, meanwhile, rose from 10 percent in the early 1980s to 40 percent in 2007.

The banks invested in production abroad and extended credit at home so that Americans could continue consuming. They were helped by the Fed, which lowered interest rates after the tech bubble burst in 2000.

Too much of that money went into the housing market because the United States had outsourced manufacturing for more than 20 years. As the economist Paul Krugman put it in 2005, "These days, Americans make a living by selling each other houses, paid for with money borrowed from the Chinese." Rising house prices allowed people to refinance and get money for other purchases.

Today's plummeting housing prices demonstrate that there is a limit to this model of growth. Whether the government will pursue wage-based growth strategies depends on the next president and Congress.

The New Deal, sneered at for the last 30 years, has regained some respect. Nevertheless, after approving the bank bailout and promising future regulation, Congress refused to extend unemployment benefits for nearly one million Americans whose benefits are expiring.

There is talk now of a new stimulus package to aid the unemployed as well as struggling state and local governments. But after the patient is stabilized, what will take the place of the financial-services and real-estate industries (which certainly will not - and should not - lead the economy)?

Will government play a role in these decisions? Or will the market and the banks determine the answer?

Bad times matter, but so do politics. The postwar economy failed to maintain prosperity at the end of the 1970s. Ronald Reagan responded with a new economic model that was secured by the prosperity of the 1990s.

Recent market failures offer the next president an opportunity to change that script. Real change will require returning to wage-based growth strategies and abandoning the policies that got us into this mess.
Read entire article at Philadelphia Inquirer