Only the combination of policies to address both innovation and income inequality can build a stronger and more durable economy.

Productive Dialogue vs. Name Calling Posted July 5, 2007 10:21 AM (EST)
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Considering the economic performance of the past few years illustrates the challenges facing the U.S. economy and points the way for policy to intercede. Specifically, growth in this business cycle stayed below average and was carried by an unsustainable debt boom. Between March 2001 and March 2007, the economy grew at an annual rate of 2.6 percent, compared to 3.3 percent in the past. This growth was based on an unsustainable increase in debt. Since March 2001, household debt relative to disposable income increased over four times faster than in the 1990s. Eventually families stopped borrowing to finance consumption, resulting in less growth.

A healthier path would have been income-based growth, but income growth has been weak by all accounts. For instance, from March 2001 to March 2007, real hourly wages grew by just 2.7 percent, real weekly wages only by 2.1 percent, and average monthly job growth was the lowest since the Great Depression. Moreover, the share of private sector workers with a pension dropped from 50.3 percent in 1995 to 45.0 percent in 2005 and the share of people with employer-provided health insurance fell from 63.6 percent to 59.5 percent at the same time.

With consumption fuelled by unsustainable debt growth, businesses held back on investment. Total investment peaked at 10.7 percent of GDP during the current business cycle, 1.9 percentage points lower than the last investment peak. Instead, the average share of before-tax profits devoted to share repurchases and dividend payouts was the largest of any business cycle.

If it hasn't already done so, this low level of investment may ultimately contribute to permanently slower productivity growth. Researchers have recently raised questions about the measured strength of productivity growth, with Susan Houseman stating that productivity growth inappropriately included input costs that have been offshored, and Dean Baker arguing that what matters for future living standards is the productivity growth that actually adds new value to the economy. This debate over the accurate measurement of productivity growth does not detract from the fact that productivity growth has rapidly declined to less than 2 percent in 2006.
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Also, business investment requires sustainable consumption growth via stronger income gains. While increases in income inequality have been well documented, observers such as Jacob Hacker, Elizabeth Warren, and Jeff Madrick have also highlighted the growing inequality of opportunity that has resulted largely from increased household debt, slow income growth, and declining insurance coverage. For instance, the share of families that could sustain an economic emergency equal to three months' income gradually rose throughout the 1990s but fell sharply after 2000, so that by 2003 all gains of the 1990s had been erased. This likely contributed to the sense of financial uncertainty that is evident in polls and may leave fewer families willing to take risks, e.g. start a business or pursue more education. Policies that could help raise middle-class security and create new opportunities include more portable health and pension benefits, more equitably distributed incentives for personal saving, and more support for training in addition to a higher minimum wage, more opportunities to join unions, and more progressive taxes.

Only the combination of policies to address both innovation and income inequality can build a stronger and more durable economy. ..